&EPA
United States
Environmental Protection
Agency
Pollution Prevention
and Toxics
(7406)
EPA 744-B-96-001
September 1995
Environmental Cost Accounting
and Capital Budgeting
Handouts to Accompany Videotape Seminar
Sponsored by the U.S. Environmental Protection Agency's
Design for the Environment Program and
the National Institute of Standards and Technology's
Manufacturing Extension Partnership
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NIU
Professional Development
Videoconf erence for Technical
Assistance Providers
Environmental Cost
Accounting and Capital
Budgeting _ _
Wednesday, July 1 2, 1 995
8am-2pm Pacific • 9am-3pm Mtn • 10am-4pm Central • 11am-5pm ET
Live, Interactive Satellite Broadcast for Technical Assistance Providers
Seminar Description
Many firms are not aware of the full range of environmental costs
(or savings) associated with their manufacturing operations. Such
costs result from product design decisions/ choice of process technol-
ogy, and waste management practices. In today's rapidly changing
regulatory environment and increasingly competitive marketplace,
environmental costs can make the difference between profitable and
unprofitable product lines and capital investments.
Identifying, tracking, reporting and using environmental cost
information to support internal management decision-making is
integral to remaining ahead of environmental regulations and ensur-
ing long-term business competitiveness both in the U.S. and abroad.
Benefits
This seminar will:
• introduce the elements of environmental accounting, with a special
focus on the financial analysis of pollution prevention and other
environmental capital projects
• review the basic mechanisms of conventional project profitability
analysis, as well as the elements of Total Cost Assessment (TCA), a
methodology for the comprehensive financial assessment of envi-
ronmental projects, and
• provide actual applications of TCA to illustrate the value of adopt-
ing a TCA approach to ensure that prevention-oriented projects are
given a "level playing field" when firms consider how best to
allocate their capital resources across market expansion, cost-
reduction, and compliance" investments.
Sponsored by: The U.S. Environmental Protection Agency
(EPA), and the National Institute of Standards &
Technology (NIST), U.S. Department of Commerce
United States Department of Commerce
National Institute of Standards and Technology
Speakers
This live, interactive seminar will
feature presentations by Allen
White, Ph.D., and Deborah
Savage, Ph.D., experts in
financial analysis of pollution
prevention projects. Bill
Schwalm, manager of
Environmental Programs
Manufacturing for Polaroid
Corporation, Waltham,
Massachusetts, will discuss the
corporation's environmental
cost accounting system.
Moderator
Mike Jackson
who serves as moderator for
the Modem Manufacturing
Videoconference Series, is
owner of a Chicago-based
corporate communications
consulting firm, Jackson
Communications Management,
Inc. A former Chicago
television news anchor and
reporter, Jackson holds an M.S.
degree from Northwestern
University. His firm provides
internal and external corporate
communications services, video
production and presentation
training.
To register, contact the Manufacturing Extension office in your area,
Continuing
Education
Units: .5
or call NTU at (970) 495-6424
Course Code: MC95071201
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Page 2 _____^__
Modem Manufacturing Series
July 12,1995
Intended Audience
The seminar is designed for trainers and technical assistance providers in the areas of industrial
environmental management and project profitability analysis, especially those whose work is oriented
to pollution prevention and waste minimization in manufacturing firms. The information and ex-
amples presented will be accessible both to viewers with little previous exposure to financial analysis
methods and to those with some experience in this area. Viewers with a formal background in indus-
trial, materials, product and environmental engineering, accounting, and general business management
will benefit.
Company Case Study
Bill Schwalm, Environmental Programs Manufacturing, Polaroid Corporation, Waltham, Massachu-
setts, will discuss Polaroid's Environmental Accounting and Reporting System (EARS) and also
Polaroid's Total Quality Ownership (TQO) initiative, the goals of which are to build environmental
goals into business systems and improve both simultaneously. With respect to the implementation of
Total Cost Assessment (TCA) of pollution projects, Bill Schwalm and colleagues will discuss a recent
capital project involving the installation of a closed-loop, multi-purpose solvent recovery still at a
Polaroid facility.
Presenters
Allen L. White
is Vice President
and Director of
the Risk Analysis
Group at Tellus
Institute in
Boston. Dr.
White's work
focuses in four
areas: environ-
mental account-
ing, pollution
prevention
economics,
corporate envi-
ronmental performance indicators, and life cycle
analysis. He has managed projects for the U.S.
EPA, state governments, and. numerous corpora-
tions on Total Cost Assessment (TCA), an alter-
native approach to evaluating the profitability of
corporate pollution prevention investments. In
work with the private sector, projects have
included assessment of the managerial account-
ing practices and the financial analyses of spe-
cific projects in the chemical, pulp and paper,
automotive, pharmaceutical, metal fabrication,
and other sectors. Most recently, he initiated
projects for U.S. EPA on the economics of cleaner
technologies in the dry cleaning and printing
industries.
Deborah E.
Savage,
a Ph.D. chemical,
engineer, is a
research associ-
ate in the Risk
Analysis Group
at Tellus Insti-
tute. Her aca-
demic back-
ground includes
teaching experi-
ence at both the
undergraduate
and graduate
levels. At Tellus, Dr. Savage focuses on pollu-
tion prevention and cost accounting. She has
assisted a number of industrial firms in the
financial analysis of pollution prevention
projects, including those in the automotive,
printing, and chemicals sectors. In addition, she
has collaborated on TCA projects with the states
of New Jersey and Illinois. Dr. Savage is a
Visiting Lecturer in the Chemical
Engineering Department at MIT.
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Revised Broadcast Schedule
(All times listed are Eastern Time)
11:15-11:45
Environmental Cost Accounting and Capital Budgeting
Allen L. White, Ph.D.
Tellus Institute, Boston, MA
What is environmental accounting?
How can environmental accounting benefit business operations?
Comments from an industry supporter of environmental accounting
U.S. EPA's Design for the Environment (DfE) Program
What is the connection between capital budgeting and environmental accounting?
Project feasibility analysis
11:45-11:55
Question-and-Answer Session
Mike Jackson, Moderator
11:55-12:30
Lunch Break
12:30-1:20
Basic Concepts of Project Financial Analysis
Deborah E. Savage, Ph.D.
Tellus Institute, Boston, MA
The Cash Flow Concept
The Time Value of Money
Inflation of operating cash flows
Another important cash flow - Taxes
Calculating after-tax cash flows
Discounting of after-tax cash flows
Cost of Capital
Financial Indicators
What are the potential shortcomings of conventional capital budgeting practices?
1:20-1:30
Question-and-Answer Session
Mike Jackson, Moderator
1:30-1:45
Break
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1:45-2:35
Total Cost Assessment (TCA)
Allen L. White and Deborah E. Savage
• What is Total Cost Assessment (TCA)
• The importance of a complete cost/savings inventory
• The importance of accurate cost allocation
• Cost estimation - how, where, and who?
• Project time horizon and profitability indicators
2:35-3:10
Lunch Break
3:10-3:50
TCA Examples
Deborah E. Savage
An example from the pulp and paper industry
An example from a metal fabrication and finishing firm
Case Study:
The Batch Still Project
Polaroid Corporation Freetown Facility, Massachusetts
Bill Schwalm (Environmental Programs Manufacturing),
Ken McCarthy, Dennis Pelletier, Walter Dickerson
3:50-4:05
Break
4:05-4:30
Summary and Conclusions
Allen L. White and Deborah E. Savage
• Conclusions
• Barriers to TCA
• Is the effort to implement TCA worth it?
4:30-5:00 Panel Discussion and
Question-and-Ansvver Session
Moderator: Mike Jackson
Panel: Allen L. White and Deborah E. Savage, Tellus Institute
Bill Schwalm and Peter Braudis, Polaroid Corporation
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 11:15am to 5:00pm Eastern - MC95071201
Environmental Cost Accounting
and Capital Budgeting
July 12,1995
11:15am - 5:00pm Eastern
Slld*1
What Is Environmental
Accounting?
SUd«2
Environmental Accounting
is the
• Identification
• Compilation
• Analysis
• Use
• Reporting of environmental information
SUd»3
1995, Tellus Institute.
Session 1
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
Environmental Accounting
Includes
Material* Accounting
• toxic materiala uae
+ waatewatar
generation rate*
• natural reiource
X
Coat Accounting
e.g-
• nazardoua waate
dlapoaal coata
• regulatory
compliance coata
• alia clean-up cost*
Slid* 4
Cost Boundaries
fm Internal Coat Domain —i
I-Full Coata
External Coat Domain-J
Slides
Conventional Company Costs
• Equipment
(Planning, Equipment, Installation)
• Direct Materials
(Raw Materials, Catalysts, Solvents)
• Utilities
(Electricity, Fuel, Water, Steam, Sewerage)
• Direct Labor
(Operating, Supervision, Clerical)
•Waste Management
(Treatment, Hauling, Disposal)
aid. 6
1995, Tellus Institute.
Session 1
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 -11:15am to 5:00pm Eastern - MC95071201
Less Tangible Costs
• Liability (Superfund, Personal Injury, Property
Damage)
• Future Regulatory Compliance Costs (e.g., CAA
Amendments, CO2)
• Value Of Marketable Emission Credits (e.g., SOx,
NOx)
• Green Product Sales (e.g., Chlorine-Free Paper)
• Employee Safety And Health Compensation
• Production Capacity Due To Emission Limits
• Corporate Image/Market Share
SM*7
External Costs
• Natural Resource Depletion
• Human Health Impacts
• Buildings/Infrastructure Impacts
• Crop Impacts
• Wetlands
• Biodiversity
• Climate Change
Slides
Cost Boundaries
ConventtonaljCompanylCoats
Internal Cost Domain —i
r- Full Costs
External Cost Domain—I
SlkteS
1995, Tellus Institute.
Session 1
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12,1995 -1 l:15am to 5:00pm Eastern - MC95071201
Environmental Accounting
vs. "Other" Accounting
Environmental materials and cost Information is
Just part of the larger framework of total
materials and coat information
There is often overlap between environmental
accounting data and other accounting data.
Therefore, it la not alwaya obvioua which data
are "environmental'* or "non-environmental."
The ultimate goal la to ensure that
environmental accounting information is alwaya
Included in the larger framework.
SIM* 10
Environment*! Costs at Amoco'* Yorktown Refinery
ss a Parcinug* of Optrstlng Costs (Excluding Cruds)
71.1V
TeMEmkonimflM 21.9%
4J%
a7%
•Sulphur ItacoMry 1.1%
•Product Speculation* 2.7%
| QAdmlnlstraUon 24%
mtlOm O2%
QUilnMnira 13%
2£%
Sourac i
How Can Environmental
Accounting Benefit Business
Operations?
sad.12
1995, Tellus Institute.
Session 1
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
How Environmental Accounting
Information Is Used
/ \
for
Internal
Monitoring &
Decision-Making
for
External
Communication &
Regulatory
Compliance
SIM* 13
Environmental Materials
Accounting Information
Internal Uses External USM
Measurement of
company progrett
towards toxics
use/release reduction
Performance
benchmarking
Identification of
pollution prevention
opportunities
• Regulatory
compliance
reporting to
EPA, state
agencies
• Public reporting
to local
community,
customers,
stockholders
1
SIM* 14
Environmental
Cost Accounting Information
\
Internal Uses
• Process
costing/product
pricing
• Product retention
and mix decisions
• Investment
decision-making
External Uses
" » Standards or
compliance
reporting to the
SEC, FASB
• Influence stock
market's
perception of the
firm
SlktolS
1995, Tellus Institute.
Session 1
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
Survey Response
Tracking Environmental Costs Company-Wide
SIM* 16
U.S. ERA'S
Design for the Environment
(DfE) Program
DfE
U.S. EPA's DfE program was initiated in 1992.
DfE's vision is to help business decision-
m«kcrs integrate environmental concerns into
cost and performance criteria.
Performance
Decision
Slid* IS
1995, Tellus Institute.
Session 1
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
DfE Industry Sectors
• Aerospace
• Dry Cleaning
• Metal Finishing
• Printed Wiring Board
• Printing
Financial Community Approach
• Insurance Project
• Finance/Lending Project
• Accounting/Capital Budgeting Project
DfE
Environmental Accounting Activities
• Develop, Pilot and Disseminate Analytical
Tools and Methods
• Curriculum Development
• Organizational Barriers and Incentives
• Facilitate Dialogue
1995, Tellus Institute.
Session 1
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
What Is the Connection
Between Capital Budgeting
and Environmental Accounting?
SIM* 22
Capital Budgeting
• Capital Budgeting is the decision-making
process a firm goes through in
determining how best to invest its
available funds •
• Usually, a firm must choose between
multiple investment options
• Capital Budgeting teane of many business
planning efforts that can benefit from good
environmental accounting
SMI 23
Capital Budgeting of
Environmental Projects
More comprehensive and accurate cost
information obtained through environmental
accounting gives a more accurate picture of
the true costs and savings generated by
environmental projects
This levels the playing field so that
environmental projects can compete for
scarce investment funds during the capital
budgeting process
1995, Tellus Institute.
Session 1
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
Survey Response
Capital Budget Pools
Separate for
Separate for all compliance projects
environmental projects^
11%
One pool for all capital projects
86%
SUdtZS
The Connection Between Environmental
Accounting & Capital Budgeting
Environmental Accounting
Materials Accounting Cost Accounting
/ X / X
Internal External Internal External
materials
Info
Capital Budgeting Process
SUd>26
Capital Budgeting Is an Internal
Process
• It is important to note that capital
budgeting is a managerial accounting
activity
i Managerial Accounting is the process of
preparing business information for internal
audiences, principally for internal
decision-making
i Managerial Accounting (and therefore
capital budgeting) is unregulated and can
vary widely from firm to firm
SIM* 27
1995, Tellus Institute.
Session 1
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
Capital Budgeting
at Small Companies
• The smaller the firm, the more likely that
the capital budgeting process will be
informal and ad-hoc, i.e., without formal
guidelines or regular timing
i Efforts aimed at assessing and improving
the capital budgeting procedures at small
firms must strike a balance between
ensuring accurate, consistent practices
and acknowledging the time/effort
constraints of personnel at typical firms
Project
Feasibility
Analysis
SIM* 29
How to Decide Between Projects?
In order to decide
1) which potential projects are wise
investments and
2) * which combinations of projects is
affordable during each capital budgeting
process
Someone must perform a project feasibility
analysis for each project
1995, Tellus Institute.
Session 1
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
Capital Budgeting
Options x
Project A?
Project C?
Project B?
SI Id. 31
Project Feasibility Analysis
A project feasibility analytic ia the assembly,
analysis, and presentation of data to characterize
the value of the proposed project to the firm
Technical
Analysis
Financial
Analysis
' Project '
Justification
Qualitative
Considerations
SIM. 32
Capital Budgeting Process
Project A
Feasibility Analysis
Project B
Feasibility Analysis
Technical Analysis
Financial Analysis
Qualitative Considerations
Iflcatl
Tscnnical Analysis
Financial Analysis
Qualitative Considerations
.Justification
Justification
Compare Projects
Final Decision
1995, Tellus Institute.
Session 1
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
In Summary
Environmental Accounting
*
Capital Budgeting
*
Feasibility Analysis
*
Financial Analysis
SUdcM
I
© 1995, Tellus Institute.
Session 1
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5.:00pm Eastern - MC95071201
Basic Concepts of
Project Financial Analysis
The Cash Flow Concept
The Cash Flow Concept is a common
management planning tool.
It differentiates between
costs ^ cash outflows
and
revenues/savings =3 cash inflows
SllctoS
Types of Cash Flows
Outflow Inflow
One-Time
Annual
Other
Initial
Capital
Cost
Operating
Costs
& Taxes
Working
Capital
Equipment
Salvage
Value
Operating
Savings
& Revenues
Working
Capital
Sttd«4 1
1995, Tellus Institute.
Session 2
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
Analysis Structure
There are two basic ways to structure a
project financial analysis
1) Stand-Alone Analysis
Considers only the cash flows of the
proposed project
2) Incremental Analysis
Compares the cash flows of the
proposed project to the "business as
usual" cash flows
SlkfeS
Project Cash Rows: Stand-Alone Analysis
e.g., for a new product line
Initial
Capital
C°*t
**•
Salvage Value
CMh
Inflows
Cash
Outflow*
11 1
M T
Annual Tax
purchase operating
Cost* e.g.,
materials, tabor
Annual
Revenue*
e.g., from
product
sale*
Working
Capital
Project Cash Flows: Incremental Analysis
e.g., for modification of an existing process
Initial
Capital a
Coat
e.g.,
equipment
purchase
Cash
Inflows
Cash
Outflows
Annual
Incremental
Operating Coats
e.g., Increased
utility costs
Tax
Annual
Incremental
Savings
e.g., reduced
waste
disposal costs
Working
Capital
Sild«7
1995, Tellus Institute.
Session 2
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
Incremental Analysis Example
• Many environmental projects are
worthwhile because project
implementation reduces annual operating
costs when compared to "business as
usual"
i An incremental analysis example of a
project from the pulp and paper industry
follows: The White Water/Fiber Reuse
Project
SIMM
Specialty Paper Mill
i Manufactures 200 tons/year of uncoated
and coated fine papers
• Coating is a latex (non-solvent)
formulation containing clay, styrene
butadiene, starch, and polymers
i As a sheet of paper travels across the
paper machine, a mixture of water and
filler (i.e., "Whitewater") and residual fiber
drains off into a collection system
SIMS
White Water/Fiber Reuse Project
Current Conditions
• 2 Paper Machines Share One White Water
System
• One Machine Has A Dedicated Saveall
Problems
* White Water From Two Machines Often
Incompatible
• White Water Is Sewered - Loss Of Fiber,
Filler, Water
Slid* 10
1995, Tellus Institute.
Session 2
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
White Water/Fiber Reuse Project
Proposed Solutions
• Separate White Water Systems, And
• Install Dedicated Saveall For Second
Machine
Benefits
• Recovery And Reuse Of Fiber And Filler
• Recovery And Reuse Of Water
Slid* 11
WW/Fiber Reuse Project
Cashflows: Incremental Analysis
Ont-tlm* Annual
Capital Coats Operating Coats
Bustntss
As
Usual
WW/Fltur
Riun
Project
0
$1,469,404
*
$799,940
$449.250
A
I«UI«I **«•»•
> Annual
lncr« mental
C«U!MM» —
savings s
$350,690
4
Annual
Outflow
SIM. 12
Cash
Inflows
Time I Y
WW/Flber Reuse Project
Cash Flow Timing
Annual Incremental Savings
I3iO,690 5350,690 $350,690 $350^90 $350,690
-n~i^~i
Etc.
\t * * * *
_ . ^v Annual Tax Payments
cash ^ _ ,. , _ .
Outflows fS1^^
Project Lifetime
Slid* 13
© 1995, Tellus Institute.
Session 2
-------
National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 11:15am to 5:00pm Eastern - MC95071201
Generic Cash Flow Timing
Incremental Analysis
Ca8h Annual Incremental Savings Working Capital
Inflows • I I I , I Salvage Value
Time I
v«ar
Zaro
r
casn Annual Tax Payments
Outflows
f Working Capital
Capital Cost
SHU* 14
Working Capital
Working Capital is the total value of goods
and money necessary to maintain project
operations
It includes items such as:
• Raw Materials Inventory
• Product Inventory
• Accounts Payable/Receivable
• Cash-On-Hand
SIM* IS
Timing of Working Capital
Cash Sale of Inventory
Inflows j
Time H vur
Zero! 1
Cash
Outflows
End
of
Project
e.g. Purchase of Raw Materials Inventory
SlktolE
1995, Tellus Institute.
Session 2
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12,1995 - 11:15am to 5:00pm Eastern - MC95071201
Salvage Value
Salvage Value Is the resale value of
equipment at the end of the project's
lifetime.
Cash Sale of Equipment
Inflows 1
Tlmegy«rQ Bill
Zero 0 ,,'fl,, 2B 3H 4q 5B
Cash
Outflows
End
of
Project
SUttolT
The
Time Value of Money
The Time Value of Money
A dollar today is worth more to you than a
dollar next year, because of
• Inflation
• Investment Opportunity
1995, Tellus Institute.
Session 2
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pmEastern - MC95071201
Inflation
Money loses purchasing power over time as
product/service prices rise, so
A dollar today can buy more than a dollar
next year.
Inflation
Cup of coffee Cup of coffee costs
costs S1 now $1.05 a year from now
Investment Opportunity
A dollar that you invest today will bring you
more than a dollar next year-having the
dollar now provides you with an investment
opportunity
Investing
$1 now
Gives you
• $1.10 a year
from now
interest, or
"return on investment
SIM* 21
Cash
inflows
Time v
Zero ,
\
WW/Fiber Reuse Project
Cash Flow Timing
Annual Incremental Savings
$350,690 $350,690 $350,690 $350,690 $350,690
ur I D I E p.
I { { 1 * l
^y Annual Tax Payments
Capital Cost
= $1,469,404
Project Lifetime
1995, Tellus Institute.
Session 2
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
Cash Flows In Different Years
In order to accurately estimate cash flows
occurring in different years and then use
that information in characterizing project
profitability, you need to adjust the cash
flows for
1) Inflation • using an inflation rate
and
2) Investment Opportunity-using a
discount rate
Inflation of
Operating Cash Flows
8UdtZ4
Adjusting for Inflation
Future Valuen= Present Value • (1 + t)n
t t \
The value of
tho cash flow
In year n,
i.e., n years
after project
start-up
The value of
the cash
flow at
"Time Zero,"
i.e., at
project
start-up
The
inflation
rate
SUd*25
1995, Tellus Institute.
Session 2
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National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
A Simple Inflation Example
A project implemented by a firm allows
manufacture of a new product, which will
bring in annual revenues of $10,000
(estimated at project start-up).
Adjusting for an annual inflation rate of 3%,
what will the revenues be during the fifth
year after project start-up?
Future Values = Present Value • (1 + .03)5
= $10,000- (1.03)5
=611,5931
SIM* 26
WW/Fiber Reuse Project: Adjustment of
Operating Cash Flows for Inflation (5%)
Future Value
Present Value of Cash Flows
of Cash Flows Inflation (In year
Year (Time Zero) * Factor = occurring)
0 -$1,469,404
1 $350,690
2 $350,690
3 $350,690
4 $350,690
5 $350,690
(1 + JOS)" = 1.0
(1 + JOSy
(1 + JOSf
(1 + JOSf
(1 + JOS?
(1 + JOSf
• $1,469,404
$368,225
$386,636
$405,968
$426,266
$447,579
Slid! 27
I
Another Important Cash Flow -
Taxes
SIM* 21
1995, Tellus Institute.
Session 2
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National Technological University - Modem Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 11:15am to 5:00pm Eastern - MC95071201
Tax Payment
Depending on a facility's location, a firm
may have to pay federal, state, and local
taxes on earnings generated by a project
Tax Payment = Tax Rate x Taxable Income
SUdtit
Taxable Income
The lower the taxable income from a project,
the lower the tax payment
One potentially significant way of reducing
taxable income is to deduct equipment
depreciation costs from the project's annual
total cash flow.
C*sh Inflow (e.g., revenues, salvage value)
- Cash outflow (e.g., operating costs)
- Tax depredation
* Taxable Income
Depreciation
Depreciation is the loss in value of a
physical asset (e.g., a piece of equipment)
as the asset ages.
This loss in value can occur for a number of
reasons, including physical deterioration,
technological obsolescence, etc.
1995, Tellus Institute.
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July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
Tax Depreciation
The Internal Revenue Service (IRS) allows
companies to deduct the cost of a (one-time)
equipment purchase over a period of years
that approximates the equipment lifetime.
The IRS specifies various property types
and lifetimes for tax depreciation purposes.
SIM. 32
Depreciation Periods
Type of Property Depreciation Period
Automobiles, office —————.
machinery, computers
Office equipment,
most manufacturing
equipment
Buildings and real
estate
5 years
7 years
31.5 or 39 years
SlktaSS
Depreciation Methods
There are a number of depreciation methods
(i.e., depreciation equations) for calculating
equipment depreciation over the
equipment's lifetime.
However, for tax depreciation purposes, the
IRS specifies several acceptable methods:
• Straight Line (SL)
• Double Declining Balance/SL (DDB/SL)
• 150% Declining Balance/SL (1.5DB/SL)
Slid* 34
S) 1995, Tellus Institute.
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July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
A Simple Tax Depreciation Example
Straight Une (SL) Tax Depreciation:
The annual tax Original Equipment Coat
Depreciation Period
depreciation amount
For a $7000 place of manufacturing equipment, with
a correapondlng depreciation period of 7 years
annual tax
depreciation
57000
7
51000/year
f or years 1 -7
of equipment uae
Slid* 35
WW/Fiber Reuse Project
Tax Calculation
YMT
R*v*nue*
+ Operating
(Co«tiys*v
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After-Tax Cash Flows
The After-Tax Cash Flow (ATCF) for each
year of the project lifetime should take into
account all of the cash inflows and outflows
generated by the project:
• Initial Investment Costs
• Annual Revenues
• Annual Operating Costs/Savings
• Annual Taxes
• Working Capital
• Equipment Salvage Value
SIM*3S
WW/Fiber Reuse Project
After-Tax Cash Flows
I
Y**r 01-2345.
RmnuM 00000
» Operating
(CtttoVSnfngi , 3CU25 316,836 40SJ6a 426368 447,579
• Tin* -CU22 • K,735-10U24-119,402-U4419
• Inmliimil -1.4ra.404
* Working Capitol 0
* S*h)»9*V»lu« '
AIUr-TuCuh -1,468,404 +299,303 4299J01 +302,444 +306,774 +312.760
Flow (ATCF)
SIM* 39
Discounting
of After-Tax Cash Flows
SIM* 40
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Investment Opportunity
At any given time, a company usually has
multiple opportunities for investing its
capital.
When the firm decides to invest in a
particular project, the firm is, in effect,
giving up other potential investment
opportunities that could also be profitable.
SIM* 41
Opportunity Cost and Discount
Rate
The cost of turning down the alternate
investment opportunities is reflected in
project financial analyses by adjustment of
the cash flow using a "discount rate."
A company's discount rate can be viewed as
the rate of return that the company expects
from an average risk investment
SIM* 42
When to use the Discount Rate
As an illustration, take a look ahead to:
Net Present Value (NPV), a "profitability
indicator," i.e., a number that characterizes
the financial consequences of an
investment
NPV s The sum of the discounted cash
inflows and outflows over the lifetime
of a project
1995, Tellus Institute.
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July 12,1995 - 11:15am to 5:00pm Eastern - MC95071201
WW/Fiber Reuse Project
Year
0
1
2
3
4
5
NPV Calculation?
After-Tax
Cash Flows
• $1 ,469,404 Time 0 dollars
+299,303 Year 1 dollars
+299,901 Year 2 dollars
+302,444 Year 3 dollars
+306,774 Year 4 dollars
+312,760 Year 5 dollars
NPV, = SUM = 7?
In order to
add up these
project cash
flows, the
future year $
must be
discounted
back to
TtmeOS
SIM* 44
Use of the Discount Rate
The company's discount rate (d) (i.e., the
rate of return expected on investments) can
be used to convert future year dollars to
time 0 dollars.
Present value =
Future Value..
(1+d)n
Discount rate = d
Discount factor =
(1+d)n
n = future year of interest
SIM* 45
WW/Fiber Reuse Project Discounted Cash Flows
Discount Discounted
After-Tax Factor After-Tax
Year Cash Flows * %*-i'}" = Cash Flows
0 -$1,469,404
1 + $299,303
2 + $299,901
3 + $302,444
4 + $306,774
5 + $312,760
%..*}• = 0-862
>6 *.«>* = 0-743
^,.,,^ = 0.641
J^.,,,4 = 0.552
XI*.")53 °-476
- $1,469,404
$258,020
$222,875
$193,763
$169,429
$148,909
|NPV5 = - $476,408 1
Time 0 $ ]
1995, Tellus Institute.
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Cost of Capital
SUd*47
Sources of Capital
A company can have several sources of
capital S for investment These sources fall
into two broad categories:
Equity Capital
Cash on-hand
Stockholder funds
Debt Capital
Bank loans
Bondholder funds
Each source of capital has an associated
cost, e.g., the interest paid to a bank for a
loan
Cost of Capital
Rather than trying to identify the exact
source of capital (and its associated cost)
for each individual project, the firm usually
develops a single "Weighted Average Cost
of Capital" (WACC) that characterizes the
sources and cost of capital to the company
as a whole.
SHd*4B
1995, Tellus Institute.
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Discount Rate = Cost of Capital
The Discount Rate used by a firm to
discount the cash flows in a project financial
analysis is usually the firm's WACC, often
simply referred to as the firm's Cost of
Capital.
In »um, Discount Rate = Coat of Capital
or
Rate of Return Expected
on a Project of Average
Risk
Weighted Average
Cost of Capital to
the Firm
'SIM* SO
How to Obtain a Cost of Capital
A company may or may not be able to
provide an estimate for its cost of capital
• Large firms usually have an estimate,
but may consider It to be confidential
business information
• Small firms may not have an estimate at
all
There are methods for calculating an
approximate cost of capital for a firm
Slid* 51
Sensitivity Analysis
In the absence of a reliable estimate of a
company's cost of capital, the best
approach is to do the financial analysis with
several reasonable values, to illustrate a
corresponding range of results.
This type of sensitivity analysis can also be
done if other data in the analysis are
uncertain.
Slid. 52
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And What About Loans?
It la important to note that principal and
Interest payments from loans are not
explicitly included in a project's discounted
cash flow analysis.
This is because the discount rate, i.e., the
company's weighted average cost of capital,
already includes consideration of loans (a
type of debt capital) taken by the firm.
SIM* S3
Financial
Indicators
Financial Indicators
A financial indicator, or "profitability
indicator" is a single number that is
calculated for characterization of project
profitability in a concise, understandable
form.
Common examples are:
Simple Payback
Net Present Value (NPV)
Internal Rate of Return (IRR)
SUd*S5
1995, TeUus Institute.
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What Are The Potential
Shortcomings of Conventional
Capital Budgeting Practices?
Slid. 66
Potential Shortcomings of
Conventional Practices
• Incomplete Cost/Savings Inventory
• Misallocation of Costs
• Inadequate Time Horizon
• Inappropriate Financial Indicators
Slid. 57
1995, Tellus Institute.
Session 2
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What Is
Total Cost Assessment
(TCA)?
Slldtt
TCA
Total Cost Assessment (TCA) is a generic
term for the long-term, comprehensive
analysis of the internal costs and savings of
pollution prevention and other
envirdnmental projects
Slid. 2
Costly Environmental Projects?
Interest in TCA and related approaches was
originally triggered by the observation that
environmental projects historically have
been viewed as profit-sustaining
(compliance/maintenance) projects, rather
than as potential profit-adding projects.
Slid* 3
1995, Tellus Institute.
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TCA for Environmental Projects
A TCA approach can be used for the
financial analysis of any type of project.
However, TCA is particularly useful for
projects with significant environmental
components because environmental
projects tend to involve costs and savings
typically neglected by conventional
practices.
SIM* 4
Elements of TCA
TCA corrects some of the flaws of
conventional financial analysis practices by
incorporating:
•A comprehensive cost/savings
Inventory
• Appropriate cost allocation
• Longer analysis time horizons
• Suitable profitability indicators
sadts
The Importance
of a Complete
Cost/Savings Inventory
SIM* 6
1995, Tellus Institute.
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July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
Cost/Savings Inventory
There are numerous potential costs and
savings associated with industrial projects.
Some cost and savings are specifically
environmental (e.g., waste disposal costs)
and some are more generic (e.g., operating
labor).
Slid. 7
Major Cost
Initial Costs
i Buildings and Land
i Purchased Equipment '
i Materials
i Utility Systems and
Connections
i Planning/Engineering
i Site Preparation
i Construction/Installation
i Start-up/Training
i Permitting
i Working Capital
i Contingency
Categories
Recurring Costs
• Materials
• Labor and Supervision
• Utilities
• Waste Management
• Regulatory
Compliance
• Insurance
• Future Liability
• Revenues
SJktot
Which Costs Are Typically
Neglected?
Less Likely To Be
Neglected
• One-Time Investment
Costs
• Direct Costs
• Certain Costs
• Short-Term Costs
• Easily Quantifiable
Costs
More Likely To Be
Neglected
• 'Annual, Recurring
Costs
• Indirect, Hidden Costs
• Uncertain,
Probabilistic Costs
• Long-Term Costs
• Dlfficult-To-Quantify
Costs
Slid* 8
1995, Tellus Institute.
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Examples of Costs/Savings
Typically Included
Investment Costg
• Purchased equipment
• Construction/Installation
Annual. Bacurrlno Costs
• Raw material*
• Operating labor
• Waste hauling and disposal
Direct, Certain
Easily
Quantifiable
aid. 10
Examples of Costs/Savings
Typically Neglected
Qno-TlmB Investment Coati
• Start-up/training
• Permitting
Annual. Recurring Costs
• Regulatory compliance
• Green market revenues
• Liability
ues V.
Indirect
Hidden
Uncertain, Probabilistic
Difficult-To-Quantify
Long-Term
Slid. 11
Survey Response
Costs Normally Considered In Financial Analysis
SUd«12
1995, Tellus Institute.
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Survey Response
Costs Normally Considered in Financial Analysis
Percent
who
consider
1
Cost Item
>n-
US
Energy costs
i l^ffMttM»»^!«
Licensing/permitting
Production efficiency/yield
^^aa^^^^&istt^^^
On-site hazardous waste handling (storage, labeling)
Employee safety/health compensation claims
78
76
74
70
69
Source: Environmental Capital Budgeting Survey . Tellus Institute, for U.S. EPA, June 1995
Slide 12
(Larger size to show detail)
1995, Tellus Institute.
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(cent.)
Co*tK»m
Fuort ragtutoryccrrcMnctcocts
|T«* eon •Mrfc tHHtiHimSfByf.
ttumiic
* costs
BSS*H!
FKftntiiifun
lyuryoirni
t>L6<»rhrmn»o«na»fT
rtOUwScy ot plirt shutdown
'
Prcptftyoimlig*
.ttitttSSSI?
laoxBJ rvcourca Ovnagt
"itiiiiitbor*
•foT*>
yy^,|-ry^»|,tnTttai'i'""' ••'••••T'™"™"
e*ytiK!^T*8^i»M»»gs*»5ijai
SI)M oTcrnnrontrarially frwridrjiqrMri pro
«*«-3*S-Efer*,-->i
**n products
50
Slid. 13
Survey Response
Cost Items for which Specific Values Are Calculated
Among Those Who "Consider* Each Cost
Cattlutn
fiaais
«*w?
«**si$ffi
!b?i
f»jl
•anut
«*«BS«
^*t!«sr^
On to« ftir •msuc
n to« or •m&uon conerots
jpn'iar
l^^^yg-vasL^SL'SSS!
SuH tritrmg lor trivironnnnlifcornpliiric*
fOkn naUlfciy'tgrnphiioi ebi>i?*^.^--i£
Kiutl mourc* flirrjje ^
)tepw>lflteiOoi'*"nt«0 KM"*""
Cotpona ITU j« iH«cu
who
calculMi
75
-!*»t%g-«^I'
-^—
:*n-it*j,n~tS*nT,.-!,r,?,i,u«*r.iotvi.fr/^tu*\m
SUttalS
1995, Tellus Institute.
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July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
(cont.)
Cost Item
Future regulatory compliance costs
Environmental penalties/fines
i^.^ >*• ««*- ,-t*..in.......!.*wz*~..*
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Survey Response
Cost Items for which Specific Values Are Calculated
Among Those Who "Consider" Each Cost
Cost Item
Energy costs
Marketable by-products
Ilii^MgSiintMS
Qn-site air/wastewater/hazardous waste testing/monitoring
insurance costs
On site air emission controls
_
Percent
who
calculate
92
89
84
84
81
Source: Environmental Capital Budgeting Survey . Tellus Institute, for U.S. EPA, June 1995
Slide 14
(Larger size to show detail)
1995, Tellus Institute.
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(cont.)
Cost Item
Environmental staff labor time
Off-site hazardous waste transport
On-site hazardous waste handling (storage, labeling)
Sales of environmentally friendly/green products
Manifesting for off-site hazardous waste transport
Employee safety/health compensation claims 63
Staff training for environmental compliance 59
Natural resource damage 55
*-~™ -~"~ •• • • - —*"-- •""••—"- -• .—.....—.,„ „,— .„. r (((fffffftttottftjafrj-K'ffH-uY, ffiwrri iTffi^iiTriiii 11 il irmiYi imWf -^ ZfnntMiii-iwirilii111 iMft
Corporate image effects 26
Source: Environmental Capital Budgeting Survey . Tellus Institute, for U.S. EPA, June 1995
Slide 15
Percent
who
calculate
79
77
75
73
71
(Larger size to show detail)
© 1995, Tellus Institute.
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Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - ll:15am to 5:00pm Eastern - MC95071201
Why Are Costs Neglected?
Perception that
_some coits ire not relevant
—some coiu are not significant enough to
qualify
_iomo com aro too difficult to quantify
Environmental coata are often
-hidden
..assigned to overhead accounta
SIM* 16
Survey Response
Barriers to Quantifying Suparfund Liability
I
Barriers HHi, «••«•• UtHS
tfc»UJ.E?A.l—.IWi
SIM* 17
Survey Response
How Superfund Effects Are Handled
n=137
Do not consider
Superfund effects
64%
Both qua), and quant
16%
Specific $ value
8%
Qualitatively only
12%
; T«U«iUiMi««. farm. ETA. *u«l»95
Slid* II
1995, Tellus Institute.
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Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 11:15am to 5:00pm Eastern - MC95071201
Some Environmental Costs
Hidden in a Typical Cost Statement
ue of lost inputs
Incremental cost of
•ubstltuta*
•environmental cost*
of Intermediate*
environmental product
specification*
Soire:Gn«aL>d>d>i>ij>a»ponleEan
Work) Reran* luciuie. M.y. 1995
SIM* 18
Some Environmental Costs
Hidden in a Typical Cost Statement
Variable Coaia
Raw Materials
Intermediates
Additives
UHttiac,
Direct L
Pacfcigmg
Wastmmier Treatment
environmental coat*
of on-*Ke power
generation
water, power for
environmental
management
SOUKC: Gram Ledfen: Cue Sudia a Coqwrac Eat
WoU Roouna Uuuiu. Mir. 1995
SIM* 20
Some Environmental Costs
Hidden in a Typical Cost Statement
vanaow coan
Raw Materials
Intermediates
Additives
Utilities
Direct Labor
Packaging
eo*t of environmental
labeling
•take-back of used
packaging
Source- Green Ledger* Cue Sludw* in Cofponle Eamtnuneaul Acctxtatiag
Wot Id Renuicu lDUinile.Miy.l99S
Slid* 21
5) 1995, Tellus Institute.
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Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
Some Environmental Costs
Hidden in a Typical Cost Statement
RxMCeca
Scctrraor
Fbtd Labor
Dtpracuion
(Xvwaul
O*nwal S*nv«
Admnfmton
. Miy. I*M
recordkeeplng and
reporting
Uma spent on
compliance
monitoring
environmentally-
related maintenance
SIM* 22
Some Environmental Costs
Hidden in a Typical Cost Statement
nx«ICe*l»
Suxmccr
Fted Labor
Otoraoaaon
OMtianilOnctiud
Ototnl S
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How To Use The Inventory
i Consider tailoring the generic
cost/savings inventory for routine use with
specific industry sectors and/or for
specific process/project types.
i Use the inventory as a checklist in
determining if each item on the list is
• not relevant to the project
• relevant but quantitatively insignificant
• relevant and quantitatively significant
• relevant but not quantifiable
SUd.25
To Quantify Or Not To Quantify?
How do you know If a relevant cost or
savings is quantitatively significant before
you go ahead and quantify it?
You don't
Try to do at least a rough, first-cut estimate
of all quantifiable costs - then decide
whether or not refining the estimate is worth
the effort.
SIM* 26
The Importance
of Accurate Cost Allocation
SIM* 27
© 1995, Tellus Institute.
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Initial Cost Assignment
In general, costs within an industrial firm are
either
•assigned directly to the process,
product, or project directly responsible
for generating the cost
or
•first assigned to facility, division, or
company overhead accounts
SIM* 21
Survey Ffosponsa - IntUi
ta^^uiyrudU^1 """'***"•'
KaysSLassiss^
tt'l>li...l»-|^" "I""TJ
t)*i.-ujii 111. • -. i. «-.'sr~~~
r"-l^--*2!i^-f^«tfa?™™ -i-a
1 Assignment of Cost*
»*•*» IJ»^m i*a«r» *•»•»
»••» VWMi
«»<|-,>»a.,a;.i. i.ili,.M,-i t .mi
ii-~^5=--r^.g5jftgg;*2ff^f
"
^•-i.-rr1^ -i J""yi"-ffa!3l>
-,.-*• '..•f,-'.?si*;",€"fei-^s
IMr =«LL •
Ti«nli«i«M.A.J«««l9M Slid* 29
Cost Allocation
Costs initially assigned to overhead
accounts are usually allocated back to
processes, products, or projects using an
allocation basis such as
•materials use
•production volume
• machine hours
• labor hours
SIM* 30
1995, Tellus Institute.
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Environmental Cost Accounting and Capital Budgeting
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Survey Response - Initial Assignment of Costs
Environmental staff labortime
Reporting to government agencies
Insurance costs
On-site air/wastewater/hazardous waste
testing and monitoring
Manifesting for off-site hazardous waste
transport
On-site waste water pre-
treatment/treatment/disposal
On-site hazardous waste handling (e.g.
storage, labeling)
Always to Usually to Usually to Always to
overhead overhead product/ product/
process process
74 ^- .
68
26
58
23
12
58
29
Source: Environmental Capital Budgeting Survey . Tellus Institute, for U.S. EPA, June 1995 Slide 29
(Larger size to show detail)
1995, Tellus Institute.
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Environmental Cost Accounting and Capital Budgeting
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Survey Rotponae
Bull (or Allocating Coat* to Product/ProceeMS (ram Overhead
(n»S8, two answer* accepted)
SIMt31
Example of Conventional Cost Allocation
Overhead
Plant '
Management
Maintenance
Process
Utilities
Environmental
R»aul«tory
Compliance j
Assigned Directly
Process X labor costs
material* costs
waste disposal costs
product revenues
Process Y tabor costs
materials costs
waste disposal costs
product revenues
Allocation Basis Is Important
In the previous example, plant management,
maintenance, process utilities, and
environmental regulatory compliance are
allocated from overhead to the two
manufacturing processes on the basis of
production volume.
Is this reasonable?
SIM133
1995, Tellus Institute.
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All Processes Are Not Created Equal
• Process X equipment, the business start-up
equipment, is much older than the
equipment for Process Y. Process X,
therefore, requires much more maintenance
labor and parts than Process Y.
• The hazardous waste generated by Process
X is subject to more environmental
regulation than the Process Y waste.
• Process Y, on the other hand, is a high-
temperature process that requires
significant heating and cooling capacity.
SIM* 34
More Realistic Cost Allocation
Overhead Cart
Plant
Management
Maintenance
Proceu Utilities
Environmental
Regulatory
Compliance
Procjn x
60%
80%
30%
70%
Proca«i V
40%
20%
70%
30%
SIM* 35
Activity Based Costing (ABC)
Under Activity Based Costing (ABC), costs
are allocated to processes, products, or
projects on the basis of activities with a
direct relationship to cost generation.
Use of ABC will not eliminate overhead
accounts, but will ensure the availability of
more accurate cost information for
management decision-making.
s) 1995, Tellus Institute.
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White Water /Fiber Reuse Project
Cost Inclusion Comparison
X«Cost(*) Included
P « Coitfr) Partially Included
Capita! Costa
Purchased Equipment
Materials (e.g., Piping, Elec.)
Utility Systems
Slto Preparation
Installation (labor)
Engineering/Contractor
Start-up/Training
Contingency
Permitting
Working Capital
Company TCA
X
X
X
X
X
X
X
X
X
X
X
X
Operating Coils
Direct Costs:
Raw Materials/Supplies
Labor
Revenues - General
Revenues - By-products
Indirect Costa:
Waate Management:
Utilities:
Energy
Water
Sewerage (POTW)
Regulatory Compliance
Insurance
Future Liability
Company TCA
P
X
X
X
X
X
X
White Water /Fiber Reuse Project
Cost Summary (Thousands of $)
Company TCA Difference
Capital Costs $1,469 $1,469 $ 0
Operating
Savlngs/(Coits)
•) Raw Materials
Fiber and Filler Loss
Freshwater Treatment
Flocculating Agents
b) Labor
Equipment Operation
c) Utilities
Electricity
Steam
Sewerage
Subtotal
S
s
(S
(S
(5
$
$
5
422
0
29)
3)
107)
0
68
3S1
$
$
(S
(S
($
$
$
S
422
26
29)
3)
34)
393
68
911
S
$
$
$
$
$
$
*
0
26
0
0
141
393
0
seo
SIM* 39
1995, Tellus Institute.
Session 3
-------
National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
Cost Estimation -
How, Where, and Who
Solvent Use Information Flow:
hi ttw Chnnlal Opwatfen* DhrtsJon of • High-Technology Multtratloiul
SIM* 41
Who Develops Cost Estimates for
Environmental Projects?
Department | Routinely Involved (%)
Production/Operations
Environmental
Finance/Accounting
Purchasing
Legal
Vendors
Consultants
Other
65
64
64
36
20
23
38
13
Sowcc Envtrommtmtol C*fHlfi Bm4t*tt*g Smrvn, Tellua iflttJlute. for U.S. EPA. June 1995
3 1995, Tellus Institute.
Session 3
-------
National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
Solvent Use Information Flow:
in the Chemical Operations Division of a High-Technology Multinational
UST Level Gauges
UST to Building
Row Meters
Building
Production
Report
Reaction Vessel
Inlet Solvent"
Row Meters
W 1 ^
*^ f > <*
Material Control,
Group [1]
^Non-batch Solvent Usage
^Tank Farm Delivery Receipts
—Solvent Recovery Plant
Delivery Receipts
Finance Group
Material^Report [3]
'Batch Sheet [2]1
Virgin/Recovered
Solvent Ratio
SAF
Reporting
VAX
)ivision Solvent Use
"Audit Spreadsheet
Omitted Solvent Uses:
[1] Solvent recovered in the building
[2] Non-batch solvent usage (clean vessels between batches &
campaigns; purge solvent lines)
[3] Deviations from normal solvent procedures
Reconciliation:
Division Solvent Use
Slide 41
(Larger size to show detail)
1995, Tellus Institute.
Session 3
-------
National Technological University — Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
Examples of Sources of Cost Information
The enctotod table provide! examples of various
•nvironnwntal cost activities (Activity), the way
those activities might be defined for determining
frequency or volume (Cost Driver), the Information
needed to calculate the costs of the activities
(Measurement), and the sources of Information
about the activities (Source).
Activity Cost Driver Measurement Source
Some: InpnvMsYourCompMiiivcPMitica: StnUfe wd fiaucul A
a—.— D—_.. TV...... u-,i,.IMFWHn«.-iUACTTA 1M«
SIM* 43
Project Time Horizon
and Profitability Indicators
Which Time Horizon Is Best?
• To some extent, the best analysis time
horizon will be project-specific and will be
related to factors such as the equipment's
useful lifetime.
i In general, the long-term view is best, in
order to capture all relevant costs/savings.
i Once the long-term analysis is completed,
the firm can always use the information
also to review the short-term benefits of
the project.
SIM* 45
1995, Tellus Institute.
Session 3
-------
EXAMPLES OF SOURCES OF COST INFORMATION
The following table provides examples of various environmental cost activities (Activity), the
way those activities might be defined for determining frequency or volume (Cost Driver), the
information needed to calculate the costs of the activities (Measurement), and the sources of
information about the activities (Source).
ACTIVITY
Spill/Leak Incident
Reporting
Monitoring
Manifesting
Right-to-Know
Training (in-house)
Labeling
Permitting & Fees
Maintenance &
Repair (Old Equipmt)
Maintenance (new
equipment)
Solvent Disposal
Training Supplies
Protective Equipment
COST DRIVER
Number of Spills
Number of Incidents
Number of Toxics
Number of Processes
using Toxics
Number of Shipments
Number of Sessions
Number of Drums
Shipped Off-Site
Number of Toxics
Number of Gallons or
Lbs.. Discharged
Number of Machines
Number of Machines
Number of Drums
Number of
Employees Trained
Number of Sessions
Number of
Employees
Sq ft protected
MEASUREMENT
Labor Hours
SAveek
Labor Hours
SAveek
Labor Hours -
$/week
$/shipment or $/drum
Labor Hours
$/week
Labor Hours
$/week
$/drum .
Labor Hours
$/week
fees(S/chemical or/gl)
Labor Hours
$/week
spare parts/equipment
$/item
Labor Hours
SAveek
spare parts/equipment
$/item
$/drum or /lb
$/employee
$/session
$/emplovee
$/Sq Ft.'
SOURCE
Engineer Interview
Engineer Interview
Engineer Interview
Manifesting Records
Engineer Interview
Engineering Records
Engineer Interview
Engineer Interview
Accounting Records
Regulatory Documnt
Machine Manufcturer
Vendor
Outside Repair Shop
Machine Manufcturer
Vendor
Engineer Interview
Accounting Records
Engineering Records
Engineering Records
Accounting Records
Engineering Records
Accounting Records
NEWMOA = Northeast Waste Management Officials' Association
MAOTA = Massachusetts Office of Technical Assistance
Source: Improving Your Competitive Position: Strategic and Financial Assessment of Pollution
Prevention Projects, Training Manual NEWMOA and MAOTA, 1994.
Session 3 - Page 43a
-------
National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
WW/Fiber Reuse Project
Time Horizons
Original Company Analysis
Time Horizon
5 years
10 years
15 years
NPV5 = - $476,000
NPV10 = + $48,000 °
I H-*HNPV1S = + $360,000
Which Profitability Indicator?
Recall that there are a number of different
profitability indicators. These indicators can
be divided into two broad categories.
Consider the Time Does Not Consider the
Value of Money Time Value of Mqngy
NPV Simple Payback
IRR
Slid* 47
Simple Payback
Simple Payback is a financial indicator that
incorporates only information about
1) the initial investment cost
and
2) the resulting annual cash flow,
unadjusted for the time value of
money
Simple Payback
(in years)
Initial Investment
Annual Cash Flow
1995, Tellus Institute.
Session 3
-------
National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12,1995 - 1 l:15am to 5:00pm Eastern - MC95071201
NPVandIRR
Net Present Value (NPV) and Internal Rate of
Return (IRR) are more sophisticated financial
Indicators that consider both the time value of
money and all future year cash flows.
NPV * the sum of the discounted cash flows
over the lifetime of the project, using
the company's cost of capital as the
discount rate
IRR = the discount rate for which NPV = 0,
over the project lifetime, calculated
Iterative)/
SIMt48
Project Adoption Criteria
Indicator Adopt the Prolnc! If...
Simple Simple payback
Payback period
NPV NPV > 0
company
IRR IRR > dltcountrate
(coat of capital)
company
rule of thumb
SlkfcSO
Survey Response
Approval Thresholds for Environmental Projects
Compared to Non-environmental Projects
Higher for env.
proj
7%
1995, Tellus Institute.
Session 3
-------
National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995- ll:15am to 5:00pm Eastern-MC95071201
Profitability indicators
Advantages and Disadvantages
Major Advantage Major Disadvantage
Simple
Payback
NPV
IBB
Easy to use
Considers TVM
Measures project
scale
Considers TVM
Neglects TVM
Need firm's cost
of capital
Requires an
iterative
calculation
SOOtSl
Profitability Indicator Summary
• NPV is generally the most valuable,
problem-free indicator.
• Other indicators that consider the time
value of money, such as IRR, are also
useful.
• Payback should be used only for very
small projects, for a first-cut rough
screening analysis of more significant
projects, or to complement NPV/IRR
information.
Slid. S3
White Water/Fiber Reuse Project
Profitability Analysis
Company Analysis TCA 1
Total Capital Costs
Annual Savings
Financial JndiCfitQrff
Net Present Value - Vein 1-5
Net Present Value - Years 1-10
Net Patent Value -Year* 1-15
Internal Rate of Return - Years 1-5
Internal Rate of Return - Years 1-10
Intern*! Rate of Return - Year* 1-15
Simple Payback (yean)
$1,469
S 351
(S 476)
S 48
S 360
1%
17%
21%
43
$1,469 1
S 911
S 784
$2,074
S2.852
37%
46% I
48% I
1.6 I
SlktoS4 I
1995, Tellus Institute.
Session 3
-------
National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 11:15am to 5:00pm Eastern - MC95071201
Implementation of TCA
Summary of Basic Steps
1) Select • long-term but realistic time horizon
2) Develop • project-specific cost/savings
Inventory, using the generic Inventory as a
guideline. Be aura to consider lass-tangibla and
out-year Hems.
3) Develop capital and annual operating coat
estimates using the project eost/savinga
Inventory aa a check list. Be aura to consider
htdden/mlsallocated coats.
4) Adjust the annual cash flows for Inflation
SIM* IS
5) Calculate tax paymenta. Be aura to consider the
depreciation tax break
6) Calculate tho After-Tax Cash Flows (ATCF)
7} Calculate the Discounted Cash Rows (DCF)
using the company's Cost of Capital aa the
discount rate.
8} Calculate financial Indicators - NPV and IRR
8) Qualitatively describe relevant Hems not
quantified
SUd.B6
1995, Tellus Institute.
Session 3
-------
National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
TCA Examples
An Example
from the Pulp and Paper Industry
Slid* 2
The WW/Fiber Reuse Project
Summary
• Illustrates the application of TCA to a
single environmental project at a single
facility
• TCA revealed some relevant, significant
annual savings neglected by the
conventional company analysis
• The neglected items were:
• Freshwater treatment chemicals
• Freshwater pumping and heating
• Wastewater pumping
1995, Tellus Institute.
Session 4
-------
National Technological University - Modem Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 -1 l:15ain to 5:00pm Eastern - MC95071201
The WW/Fiber Reuse Project
Summary
• Inclusion of the previously neglected
savings more than doubled the annual
cash flow to the project
•This resulted in a substantial increase in
project profitability, both over the short-
term and the long-term
An Example
from a
Metal Fabrication and Finishing
Firm (MF3)
SUdlG
Metal Fabrication and Finishing
Firm (MF3)
• Privately owned
• 2 Facilities, 200 • 300 employees
• Major products and customers
- Computer cabinets for a computer
manufacturer
- Office furniture metal components for a
furniture maker
• Many environmental efforts at the firm undertaken
due to customer demand and yrith customer
assistance
1995, Tellus Institute.
Session 4
-------
National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 11:1 Sam to 5:00pm Eastern - MC95071201
Capital Budgeting at MF3
• No standard procedure
• Projects proposed to management on an
ad-hoc basis
• Environmental projects handled in the
same way as other projects
• Vendors play a key role in project analysis
• Limited costs/savings quantified
• Simple payback is the financial indicator
used
Sid. 7
Paint/Water Separator Project
Incremental Analysis
Current Condltlonn
• A couple of the fabrication and finishing steps
generate aqueous-based wastes
• water/ammonia/pigment mixture from flushing
paint spray guns
•water-soluble oil waste from matal grinding
operations
Problem
• These wastes currently manifested and shipped
off-site for incineration. Approximate hauling and
disposal: S8906/year
Slid* 8
Paint/Water Separator Project
Proposed Solution
• Installation of a 100-gallon batch system for
paint/water separation
• Suitable for both paint waste and oily waste
• Purchase of an infrared heater to dry and reduce
volume of filtered sludge
Benefits
• Recovery of separated water for recycle or
sewerage
• Reduced cost for hauling and Incinerating
residual wastes, i.e., paint solids and oil fraction
SIM* 8
3 1995, Tellus Institute.
Session 4
-------
National Technological University - Modem Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 -11:15am to 5:00pm Eastern - MC95071201
Paint/Water Separator Project
Cost Inclusion Comparison
X * Coit(i) Includid
P« Co»t(i) Partially Included
Capital Coat*
Purchaaad Equipment
Material* (e.g., Piping, Elac.)
Utility Sygtemi
SIta Preparation
Installation
Engineering/Contractor
Start-up/Training
Contingency
Paimlttlng
Working Capita!
Company TCA
Slid* 10
Operating Coata
Direct Coata:
Raw Matirlalt/Suppllaa
Waata Olapoaal
Labor
Revenues - General
Revenues - By-producta
Indirect Coata:
Waata Management:
Hauling
Storage
Handling
Waate-and FMa/Taxaa
Hauling Inaurance
Company TCA
X
P
X
X
X
X
aw. 11
Operating Coata (cont)
Utllltlea:
Energy
Water
Sewerage (POTW)
Regulatory Compliance
Inaurance
Future Uablllty
Company TCA
X
X
X
X
SIM* 12
1995, Tellus Institute.
Session 4
-------
National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 11:15am to 5:00pm Eastern - MC95071201
Paint/Water Separator Project
Cost Summary
Company
Capital Cost* $19,659
Operating
Savings/(CosU)
a) Raw Materials
b) Labor
e) Waste Disposal Mgmt
d) Utilities
e) Regulatory Compliance
Subtotal
($ 218)
($ 714)
$5,651
($ 136)
$ 0
$4,583
TCA Difference
(TCA-C«*p«y)
$19,733 $ 74 I
($ 218)
($ 714)
$6,135
($ 163)
$ 194
$5,234
$ 0 I
$ 0 1
$ 484 1
(* 27) 1
$ 194 1
$ 651 1
SIM. 13
Paint/Water Separator Project
Profitability Analysis
Company Anatvil« TCA
$19,659 $18,733
$4,583 $5,234
Total Capital Costs
Annual Savings (BIT)
Financial Indicator*
Net Pmsnt Value - Yurc 1-10
Net Pi-went Value - Years 1-15
Internal Rate of Return - Years 1-10
Internal Rate of Return - Years 1-15
Simple Ptyttck (yftn)
Paint/Water Separator Project
Summary
• TCA revealed some relevant, significant
initial and annual costs and savings
omitted in the conventional company
analysis
• The omitted items were:
• Equipment installation
• Training
• Separator sludge waste disposal
• Waste hauling and hauling insurance
• Water
• Sewerage
Slid* 15
£> 1995, Tellus Institute.
Session 4
-------
National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
Paint/Water Separator Project
Summary
• Inclusion of the omitted Kerns increased
annual operating savings of the project by
approximately 14%
•This resulted in a moderate increase in
project profitability
Polaroid
Batch Still Project
A Total Cost Assessment
Case Study
SIM* 17
I
1995, Tellus Institute.
Session 4
-------
National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 -11:1 Sam to 5:00pm Eastern - MC95071201
Summary
and
Conclusions
SIM.1
Conventional Practices Are Biased
Against Pollution Prevention and
Other Environmental Investments
Total Cost Assessment (TCA)
Can Level the Playing Field
SIM* 2
Improved Capital Budgeting
Practices Can Change
the Bottom Line
How Much Depends On Current
Company Practices and the
Individual Project
Slid. 3
© 1995, Tellus Institute.
Session 5
-------
National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
As Illustrated By Case Studies,
A TCA Approach Will Often
Improve the Profitability
Of Pollution Prevention
Or Other Environmental Projects
But There Is No Guarantee
Slid. 4
Costs, As Well As Savings...
TCA does not ensure profitability for
pollution prevention or other environmental
projects.
in addition to identifying hidden/neglected
savings generated by environmental
projects, TCA can also reveal additional
costs not captured by conventional analysis.
Slk)«S
The Paper Coating Conversion
Project
i "Business As Usual" was production of
coated papers, using a solvent-based
coating mixture and some heavy metal-
based pigments
i The alternative project under
consideration was a switch to aqueous-
based coating mixtures and heavy metal-
free pigments
SI Id. 6
1995, Tellus Institute.
Session 5
-------
National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
The Paper Coating Conversion Project
Cost Summary
Capital Costs
Company TCA
$893,449 $923,449
$30,000
Operating
Savings/(Costs)
a) Raw Materials $18,112 ($27,488)
b) Waste Disposal MgmL $118,000 $308491
c) Utilities ($5,000) ($204,776)
d) Regulatory Compliance ($5,000) $11,000
e) Liability 0 $35,000
$5,080 (tknearoj
Subtotal
(without liability)
$126,112 $87,167
($45,600)
$190491 = 1
($199,776) oi
$16,000 /r j
(year13)/!'
1—Y
($38,985)
SIMt7
The Paper Coating Conversion Project
The Bottom Line
Financial Indicators
NPV-Years 1-10
IRR-Year* 1-10
Simple Payback (yem)
Company
ICA
($314,719) ($480,512)
6% 0%
7.6
11.7
SIMll
TCA Has Wide Applicability Across
Project/Program Size and Type
Slid. 8
1995, Tellus Institute.
Session 5
-------
National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
TCA Should Be Customized To a
Firm's Needs
No One Approach Is Right for All
Slid* 10
Improvements Are Likely To Be
Incremental and Piecemeal
Slktell
Barriers To TCA
Slid* 12
1995, Tellus Institute.
Session 5
-------
National Technological University - Modern Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
Potential Barriers To TCA
• Start-up costs
• Managers may not welcome new costs in
their units
• Profitability of existing product lines may
diminish
• Future disclosure of risk/liability
information
SIM* 13
Is the Effort To Implement TCA
Worth It?
The resources necessary to
implement TCA (i.e., time and
money) depend on the level of the
effort, but can have significant
benefits not only for capital
budgeting but also for other
objectives such as product pricing.
Slid. 15
3 1995, Tellus Institute.
Session 5
-------
National Technological University - Modem Manufacturing Video Conferencing Series
Environmental Cost Accounting and Capital Budgeting
July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
Once the environmental
accounting data are available,
implementation of TCA for capital
budgeting is clearly worth the
effort, as illustrated by the case
studies. TCA provides a clear,
complete picture of the firm's
investment options.
Slid* 16
Although the case for making
improvements can be made purely
on the basis of the firm's self-
interest, improved internal
environmental accounting may
also result in multiple social
benefits.
SIM* 17
1995, Tellus Institute.
Session 5
-------
GLOSSARY OF FINANCIAL TERMS
Tellus Institute, Boston, MA
-------
Annual Cash Flow
Break-Even-Point
Capital Budget
Cash Flow (from
an investment)
Cost Accounting System
Cost Allocation
Discount Rate
Financial Accounting
Financial Reporting
Financial Statements
For an investment, the sum of cash inflows and outflows for a
given year (see cash flow).
The point at which cumulative incremental annual cash flows of
an investment aggregate to 0. The Break-Even-Point designates
the end of a project's investment Payback Period (see Incremental
Cash Flow and Payback Period).
A statement of the firm's planned investments, generally based
upon estimates of future sales, costs, production and research and
development (R&D) needs, and availability of capital
The dollars coming to the firm (cash inflow) or paid out by the
firm (cash outflow) resulting from a given investment.
The internal procedure used to track and allocate production costs
and revenues to a product or process. Defines specific cost/profit
centers, overhead vs. allocated costs, degree of cost
disaggregation.
A process within an internal cost accounting system of assigning
costs and revenues to cost and profit centers for purposes of
product pricing, cost tracking, and performance evaluation.
The discount rate (or Cost of Capital) is the required rate of
return on a capital investment. In profitability analysis, the
discount rate is used in Net Present Value (NPV) calculations to
express the value of a future expenditure in the present year. The
discount rate is expressed as a percentage.
The process that culminates in the preparation of financial reports
relative to the enterprise as a whole for use by parties both
internal and external to the enterprise.
Required by authoritative pronouncement, regulatory rule or
custom, including: corporate annual reports, prospectuses, annual
reports filed with government agencies, descriptions of an
enterprise's social or environmental impact.
The principal means through which financial information is
communicated to those outside an enterprise. Statements include
the balance sheet, income statement, and statement of cash
flows.
-------
Hurdle Rate
Incremental Cash Flow
(of an investment)
The internally defined threshold, or minimum acceptable rate of
return, required for project approval, e.g. 15% ROI, or 2 year
payback.
The cash flow of an alternative practice (e.g. after a pollution
prevention investment has been implemented) relative to the
current practice. Incremental cash flow is calculated by taking
the difference between the cash flow for the current practice and
the alternative practice.
Internal Rate of Return
(IRR)
Managerial Accounting
The discount rate at which the net savings (or NPV) on a project
are equal to zero. The computed IRR of an investment is
compared to a company's desired rate of return.
The process of identification, measurement, accumulation,
analysis, preparation, interpretation, and communication of
financial information used by management to plan, evaluate, and
control all activities within an organization to ensure appropriate
use, and accountability for its resources. Capital budgeting is one
component of managerial accounting.
An index that helps to answer the question: are the future
savings/revenues of a project likely to justify a current
expenditure? Synonyms: "decision rule", or "financial index", or
"profitability index", or "capital budgeting technique". Includes-
NPV, IRR, payback, ROI.
Net Present Value (NPV) The present value of the future cash flows of an investment less
the investment's current cost.
Profitability Indicator
NPV =
CF
isi-l
1+k
CF - I
where: CF, is cash flow in period 1
CF2 is cash flow in period 2, etc.
I is initial outlay or investment cost
k is cost of capital or discount rate
An investment is profitable' if the NPV of the cash flow it generates in
the future exceeds its cost, that is, if the NPV is positive.
-------
Payback Period
Project Financial
Analysis
Project Justification
Process
Project Justification
Return on Investment
(ROI)
Total Cost Assessment
(TCA)
The amount of time required for an investment to generate
enough cash flow to just cover the initial capital outlay for that
investment.
Payback = Investment/Annual Net Income
Costing (i.e. calculating the costs and savings) and calculating
cash flow and/or profitability measures of a project.
A generic term for a series of steps which are necessary to get
approval for a project.
A document prepared in the project justification process which
comprising a written description of the project, a project financial
analysis, and a discussion of benefits and risks which are not
quantified in the financial analysis.
A measurement of investment performance, calculated as the ratio
of annual net income (minus depreciation) over the initial
investment amount.
ROI = Annual Net Income/Investment
A comprehensive financial analysis of the costs and savings of a
pollution prevention project. A TCA approach includes:
a) internal allocation of environmental costs to
product lines or processes;
b) inclusion in a project financial analysis of direct
and indirect costs, short and long term costs;
liability costs, and less tangible benefits of an
investment;
c) evaluation of project costs and savings over a long
time horizon, e.g. 10-15 years;
d) use of measures of profitability which capture the
long-term profitability of the project, e.g. NPV and
IRR.
-------
Modern Manufacturing:
The National Videoconference Series for Successful Small Firms
Environmental Cost Accounting and Capital Budgeting
References for Additional Information
Tellus Institute, Boston, MA
Environmental Accounting
Gray, Rob. 1993. Accounting for the Environment. Markus Weiner Publishing, Inc. New
York.
Global Environmental Management Initiative (GEMI). 1994. Finding Cost-Effective Pollution
Prevention Initiatives: Incorporating Environmental Costs into Business Decision Making.
Ditz, Daryl, J. Ranganathan and Darryl Banks, eds. 1995. Green Ledgers: Concepts and
Case Studies of Corporate Environmental Accounting. World Resources Institute. March 12.
Principles of Capital Budgeting
Torborg, Richard H. 1994. "Capital Budgeting for Environmental Professionals." Pollution
Prevention Review, pp. 447-464. Autumn.
Brealey, R.A. and S.C. Myers, Principles of Corporate Finance, 4th edition, McGraw Hill
Inc., New York, 1991.
Garrison, Ray H. and Eric W. Noreen. 1994. Managerial Accounting, Seventh Edition. Irwin
Publishers, Boston.
National Association of Accountants. 1990. Statements on Management Accounting, Statement
No. 4A, Practices and Techniques: Cost of Capital. Prentice Hall Publishers; Englewood
Cliffs, NJ.
Activity Based Costing
Society Management Accounting. 1993. Statements on Management Accounting - Practices
and Techniques: Implementing Activity-Based Costing. Institute of Management Accountants;
Montvale, NJ. September.
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Cooper, Robin, Robert S. Kaplan, Lawrence Maisel, Eileen Morrissey, and Ronald M. Oehm
1992. Implementing Activity-Based Cost Management: Moving from Analysis to Action.
Montavale, N.J.: Institute of Management Accountants.
Cokins, Gary, Alan Stratton and Jack Helbling. 1993. An ABC Manager's Primer. Institute
of Management Accountants; Montvale, NJ.
Mecimore, Charles D. and A.T. Bell. 1995. "Are We Ready for Fourth-Generation ABC?"
Management Accounting, January.
Managerial Accounting Surveys
Price Waterhouse. 1992. Accounting for Environmental Compliance: Crossroad of GAAP,
Engineering, and Government. Survey #2.
Price Waterhouse 1994. Progress on the Environmental Challenge: A Survey of Corporate
America's Environmental Accounting and Management. New York.
White, A.L., D. E. Savage, et al. 1995. Environmental Cost Accounting for Capital Budgeting:
A National Survey of Management Accountants (Draft). Prepared for Office of Pollution
Prevention and Toxics, U.S. EPA. Tellus Institute. June.
Financial Analysis Handbooks and Curricula
Massachusetts Office of Technical Assistance and Northeast Waste Management Officials'
Association. 1992. Costing and Financial Analysis of Pollution Prevention Projects: A
Training Packet - Workshop Agenda, Workshop Curriculum, Case Studies and Report.
Massachusetts Office of Technical Assistance and Northeast Waste Management Officials'
Association. 1994. Improving Your Competitive Position: Strategic and Financial Assessment
of Pollution Prevention Projects - Instructor's Guide.
Massachusetts Office of Technical Assistance and Northeast Waste Management Officials'
Association. 1994. Improving Your Competitive Position: Strategic and Financial Assessment
of Pollution Prevention Projects - Training Manual.
Massachusetts Toxics Use Reduction Program. 1993. Curriculum for Toxics Use Reduction
Planners, Fourth Edition. The Toxics Use Reduction Institute, University of Massachusetts
at Lowell. Spring.
-------
United States Environmental Protection Agency. 1989. Pollution Prevention Benefits Manual.
U.S. EPA, Prepared for Office of Solid Waste and Office of Policy Planning and Evaluation.
July.
American Institute for Pollution Prevention. 1993. A Primer for Financial Analysis of
Pollution Prevention Projects. Prepared for: United States Environmental Protection Agency,
Office of Research and Development. April.
United States Environmental Protection Agency, Office of Research and Development and
Office of Solid Waste. 1992. Facility Pollution Prevention Guide. May.
Tellus Institute. 1993. P2/FINANCE User's Manual. Tellus Institute.
Total Cost Assessment Case Studies
Kennedy, Mitchell L. 1994. "Getting to the Bottom Line: How TCA Shows the Real Cost
of Solvent Substitution." Pollution Prevention Review, pp. 155-164. Spring.
White, Allen L., Monica Becker, James Goldstein 199la. Total Cost Assessment: Accelerating
Industrial Pollution Prevention Through Innovative Project Financial Analysis with
Applications to the Pulp and Paper Industry. Sponsor: U.S. Environmental Protection
Agency, Office of Policy Planning and Evaluation, Office of Pollution Prevention. Tellus
Institute Study No. 90-020. Revised Executive Summary, June 1993.
White, Allen L., Monica Becker, James Goldstein 1991b. Alternative Approaches to the
Financial Evaluation of Industrial Pollution Prevention Investments. Prepared for: New Jersey
Department of Environmental Protection, Division of Science and Research, Project No.
P32250. Tellus Institute Study No. 89-206. Revised Executive Summary, June 1993.
White, Allen L., M. Becker and D.E. Savage. 1993b. "Environmentally Smart Accounting:
Using Total Cost Assessment To Advance Pollution Prevention," Pollution Prevention Review.
Tellus Institute, Boston. Summer.
Savage. Deborah E. and Allen L. White. 1994-95.
Assessment," Pollution Prevention Review. Winter.
"New Applications of Total Cost
White, A.L., D.E. Savage and A. Dierks. 1995. "Environmental Accounting: Principles for
the Sustainable Enterprise," TAPPIInternational Environmental Conference, Atlanta, GA. May
7-10.
Wittman. Marlene R. 1991. "Wrayburn Jewelry Company, Inc., Sutton Facility: Costing and
Financial Analysis of Pollution Prevention Projects." Massachusetts Office of Technical
Assistance and Northeast Waste Management Officials' Association. July.
-------
Wittman, Marlene R. 1991. "Lightolier, Inc., Fall River Division: Costing and Financial
Analysis of Pollution Prevention Projects." Massachusetts Office of Technical Assistance and
Northeast Waste Management Officials' Association. July.
Disclosure of Environmental Liability
Edwards, Paul N. 1992. "A Comparison of FASB and SEC Accounting and Disclosure
Requirements for Environmental Contingencies," Understanding Environmental Accounting and
Disclosure Today. Executive Enterprises, Inc. New York.
Also see Price-Waterhouse surveys.
EPA DIE Resources
U.S. Environmental Protection Agency. 1993. Design for the Environment: EPA's
Environmental Network for Managerial Accounting and Capital Budgeting. Document No.
EPA 742-K-93-002; Prevention, Pesticides, and Toxic Substances. October.
U.S. Environmental Protection Agency. 1994. Environmental Accounting Resource Listing.
Document No. 742-F-94-004; Office of Pollution Prevention and Toxics. July.
Pollution Prevention Financing Sources
U.S. Environmental Protection Agency. 1995. Financing Pollution Prevention Investments: A
Guide for Small and Medium-Sized Businesses. Boston. (Focuses on sources of financing in
the Northeast states).
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Tellus Institute - Boston, MA
INVENTORY OF POTENTIAL COSTS/SAVINGS
INITIAL COSTS
*'
Purchased Equipment
Equipment - e.g. process, monitoring, preparedness/protective, safety, storage & materials
handling, laboratory/analytical
Delivery
Sales Tax
Insurance
Price for Initial Spare Parts
Materials
Piping
Electrical
Instruments
Structural
Insulation
Other Materials - e.g. painting, ducting
Utility Systems and Connections
General Plumbing
Electricity
Steam
Water - e.g. cooling, process
Fuel - e.g. gas, oil
Plant Air
Inert Gas
Refrigeration
Sewerage
Site Preparation (Labor, Supervision, Materials)
In-house
Contractor/Vendor/Consultant Fees
Demolition & Clearing
Old Equipment/Rubbish Disposal
Grading, Landscaping
Equipment Rental
Construction/Installation (Labor, Supervision, Materials)
In-house
Contractor/Vendor/Consultant Fees
Equipment Rental
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Tellus Institute - Boston, MA
Planning/Engineering (Labor, Supervision, Materials)
In-house Planning/Engineering, e.g. design, drafting, accounting
Contractor/Vendor/Consultant Fees
Procurement
Start-up/Training (Labor, Supervision, Materials)
In-house
Contractor/Vendor/Consultant Fees
Trials/Manufacturing Variances
Training
Permitting (Labor, Supervision, Materials)
In-house
Contractor/Vendor/Consultant Fees
Permit Fees
Working Capital
Raw Materials
Other Materials & Supplies
Product Inventory
Contingency
(Salvage Value)
OPERATING COSTS
Direct Materials
Raw Materials - e.g. wasted raw materials costs/savings
Solvents
Catalysts
Transport
Storage
Direct Labor
Operating - e.g. worker productivity changes
Supervision
Manufacturing Clerical
Inspection/QA/QC •
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Tellus Institute - Boston, MA
Utilities
Electricity
Steam
Water - e.g. cooling, process
Fuel - e.g. gas, oil
Plant Air
Inert Gas
Refrigeration
Sewerage
Waste Management (Labor, Supervision, Materials)
Pre-treatment
On-site Handling
Storage
Treatment
Hauling
Insurance
Disposal
Regulatory Compliance (Labor, Supervision, Materials)
Permitting
Training - e.g. Right-To-Know training
Monitoring/Inspections
Testing
Labeling
Manifesting
Recordkeeping
Reporting
Generator Fees/Taxes
Closure/Postclosure Care
Value of Marketable Pollution Permits, e.g. SOx
Avoided Future Regulation, e.g. CAA amendments
Insurance
Future Liability
Fines/Penalties
Cost of Legal Proceedings, e.g. transaction costs
Personal Injury
Property Damage
Natural Resource Damage
Superfund
Revenues
Sale of Product - e.g. from changes in manuf. throughput, market share, corporate image
Marketable By-Products
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TCA AT WORK: A CASE STUDY IN THE PULP AND PAPER INDUSTRY
Paper Coating Mill
White Water/Fiber Reuse Project
The following case study illustrates the difference between a company's financial analysis of
a pollution prevention project and a Total Cost Assessment (TCA) of the same project. The
"Company Analysis" is the financial analysis performed independently by the company to
evaluate the profitability of a pollution prevention project. In contrast, the "TCA" is a more
comprehensive financial analysis of the same project, developed collaboratively by the
company and Tellus, to illustrate the differences in profitability when a more comprehensive
approach is used. This case study describes the project under consideration and assesses both
qualitatively and quantitatively the differences in the Company Analysis vs. the TCA.
Tellus Institute, Boston, MA
From work sponsored by:
New Jersey Department of Environmental Protection
Division of Science and Research
Revised June 1993
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COATED FINE PAPER MILL
Company Background
A specialty paper mill is part of a larger corporation of pulp, paper, and coating mills. The
mill is not integrated, i.e. does not manufacture pulp. Most of the pulp used by the mill is
purchased via pipeline from a neighboring bleached kraft mill. The mill supplements this
pulp with a small amount of purchased market pulp. The mill produces approximately 190
tons per year of a variety of uncoated, on-machine and off-machine coated papers,
carbonizing, book, and release base paper. The coating used is a latex (i.e. non-solvent)
formulation containing clay, styrene butadiene, starch, and polymers.
Project Background
Papermachine white water, a mixture of water and residual fiber and filler (clay and
calcium carbonate) that drains out of a sheet of paper as it travels across the paper machine,
is typically captured by a white water collection system dedicated to one papermachine.
Some or all white water is usually recycled back into the papermaking system to recapture
water, fiber and filler. In some cases white water is passed through a saveall screening
device to separate fiber and filler from water; fiber, filler and water are then recycled back
into the system. The saveall produces a clear stream of water that can be used in numerous
papermachine operations.
In this mill, two paper machines, sharing a common white water system, produce a variety
of paper grades made with either acid, neutral, or alkaline sizing chemistry.' Machine 1
has a saveall system that filters fiber and filler prior to discharging into the joint white
water system. This material is recycled back into the papermaking system. When the
machines are using different sizing chemistry, e.g. when Machine 1 is producing acid-sized
paper and Machine 2 is producing alkaline-sized paper, the mixed white water from both
machines is not reusable, and must be sewered. Under these conditions, a large flow of
potentially reusable water from both machines, and fiber and filler from Machine 2, is lost
to the sewer.
Prompted primarily by the lack of spare water effluent pumping capacity and a desire to
better understand the rather complex, old white water piping system, the mill commissioned
a study titled "White Water Recycle Feasibility Study." The study had several objectives:
1 Sizing is added to pulp to reduce water absorbency in the final paper. The pH (i.e.
acidity or alkalinity) of the pulp must be adjusted according to the type of paper desired and
sizing used.
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"...to review the design and operation of the mill and recommend changes that would help
reduce peak effluent flows, reduce BOD in the effluent and reduce total fresh water intake
on a mill wide scale". The resulting report contained detailed engineering drawings of the
fresh water, white water, and paper machine systems and a recommendation for process
modifications.
Project Description
The recommendation made in the feasibility study was the installation of a second saveall
to handle the Whitewater from Machine 2, and the splitting of the Whitewater systems so
that each machine would have a dedicated system. This would permit fiber, filler and water
reuse on both machines at all times, thereby conserving raw materials and reducing water
consumption, wastewater generation, and energy use for fresh and wastewater pumping and
freshwater heating. The project would require installation of a new saveall, a new pump,
piping, and controls. Available pulping and stock storage capacity could be used to pulp
separately for each machine.
Project Financial Analysis
The feasibility study also contained a capital estimate for the project of $1,469,404. The
estimate includes: purchased equipment (including saveall, stock chest, clear white water
chest and associated equipment); process control instrumentation; electrical controls and
lighting; a new building for the saveall; piping; installation (in-house and contracted labor);
engineering; and contingency.
Company and TCA Analyses
The Company Analysis consists of the capital estimate, and only those operating costs and
savings that the company typically includes in project financial analyses for projects of this
type. These are:
a. raw material - fiber and filler;
b. energy and chemical use for new equipment;
c. wastewater treatment fees; and
d. changes in labor costs.
The TCA contains these and other relevant operating costs and savings. On the benefit
side, the TCA includes the following:
a.
An average reduction in fiber and filler loss of 1,200 tons/year, for a savings
of $421,530/year;
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b. A reduction in fresh water usage of 1 million gal/day, and a commensurate
reduction in cost for fresh water treatment and pumping, for a savings of
approximately $112,420/year;
c. A reduction in energy use for fresh water heating amounting to a savings of
approximately $393,400; and
d. A reduction in wastewater generation of approximately 1 million gal/day, for
a savings of approximately $54,750/year in wastewater pumping and
$68,240/year in wastewater treatment fees.
Annual operating costs are expected to increase in the following areas:
a. Chemical flocculating agents used in the saveall to promote solids/water
separation will cost approximately $28,700/year;
b. Electric costs for new equipment operation will increase operating costs by
approximately $107,280/year; and
c. An increase in labor cost of approximately $3,120/year is expected for
operation of new equipment.
The project does not affect wastestreams that require on-site management or disposal, nor
does it affect any regulatory compliance activities at the site; therefore the financial analysis
does not include costs for these activities. In addition, no impacts on revenue are expected
since neither product quality nor production rates will be improved, nor does the mill
expect to visibly enhance its product or company image. Finally, no tangible impact on
avoided future liability is expected for this project.
Table 1 summarizes the cost categories addressed in the Company Analysis and the TCA
for this project, and Table 2 reports the results of the financial analysis.
Effect of Cost Inclusion on Financial Indicators
As shown in Table 2, the inclusion hi the TCA Analysis of savings associated with
freshwater pumping, treatment, and heating, and waste water pumping dramatically
increases the annual savings and financial indicators above the Company Analysis base
case. These savings, which would typically not be included in the mill's calculation of
profitability, bring the project in line with the mill's 2 year payback rule-of-thumb. By
excluding these savings in the Company Analysis, the project looks reasonably "profitable"
only over the longer time horizon of 15 years.
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Table 1 Comparison of Cost Items in Company and TCA Cost Analyses
X = Cost(s) Included
P = Cost(s) Partially Included Company
Capital Costs
Purchased Equipment
Materials (e.g., Piping, Elec.)
Utility Systems
Site Preparation
Installation (labor)
Engineering/Contractor
Contingency
X
X
X
X
X
X
X
TCA
X
X
X
X
X
X
X
Operating Costs
Direct Costs:*
Raw Materials/Supplies
Labor
Indirect Costs:*
Utilities:
Energy
Water
Sewerage (POTW)
P
X
P
X
X
X
X
X
X
* We use the term "direct costs" to mean costs that are typically allocated to a product or process line (i.e. not
charged to an overhead account) and are typically included in project financial analysis. "Indirect costs" here mean
costs that are typically charged to an overhead account and typically not included in project financial analysis.
Table 2 Summary of Financial Data for the White Water and Fiber Reuse Project
Total Capital Costs
Annual Savings (BIT)*
Financial Indicators
Net Present Value - Years 1-5
Net Present Value - Years 1-10
Net Present Value - Years 1-15
internal Rate of Return - Years 1-5
Internal Rate of Return - Years 1-10
Internal Rate of Return - Years'* 1-15
Simple Payback (years)
Company Analysis
$1,469,404
$ 350,670
($ 476,408)
S 47,240
$ 359,544
1%
17%
21%
4.2
TCA
$1,469,404
$ 911,240
$ 783,232
$2,072,306
$2,849,725
37%
46%
48%
1.6
* Annual operating cash flow before interest and taxes
Some uncertainty exists in the wastewater treatment cost estimate. Because the mill does
not have its own wastewater treatment facility, wastewater from the mill is pumped to a
neighboring mill for treatment. In the per ton flow, Total Suspended Solids (TSS) and
4
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Biological Oxygen Demand (BOD) for the subject mill is reportedly higher than the
industry average. The neighboring mill has asked the subject mill to reduce wastewater
flow, although no such measures have been put into effect to date. The treatment charge is
not based on TSS or BOD so the subject mill has no direct economic incentive to reduce
TSS and BOD in its wastewater. The contract between the mills establishes a ceiling for
wastewater flow, BOD and TSS from the mill. Currently, the subject mill is meeting its
flow limit, but is substantially exceeding its contract limits on BOD and TSS.
The treatment contract will be renegotiated in 1993, but it is not clear whether, or how, the
terms will be changed. However, the mill's environmental, engineer speculated that the
charge rate formula might be changed to include a BOD or TSS variable, and that the
overall cost could increase. To test the sensitivity of the project analysis to these potential
changes, the TCA was recalculated twice, doubling and tripling the wastewater treatment
costs. In both cases, the financial indicators change slightly: 50% IRR (years 1-10) and
1.5 payback for double the cost, and 53% (years 1-10) IRR and 1.4 payback for triple the
treatment cost. While there is no dramatic change in projected profitability, a tripling of
wastewater treatment costs, may make this project somewhat more competitive with other
projects competing for capital in a particular budget year. This may be especially true if
the firm applies its rule-of-thumb, 2 year payback criteria as a screening test for the project.
Detailed reports of the Company Analysis, the TCA, and associated cost calculation
documentation follow.
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White Water/Fiber Reuse Project
Costing and Financial Analysis Documentation
A. Capital Costs
Purchased Equipment: $345,985
Saveall and White Water Pump
Materials: $374,822
Piping, Electrical, Instruments and Structural
Installation:
Engineering:
Contingency:
$397,148
$211,046
$140,403
B. Operating Costs
Key: M - thousand
MM - million
GD - gallons/day
Current Process
1. RAW MATERIALS
l.a. Fiber and Filler Loss (includes freight)
Estimated solids loss = 1,500 tons/yr
White water solids = 67% fiber, 33% filler
Fiber loss:
1,500 tons/yr * 0.67 = 1005 tons/yr
Fiber cost = $445/ton
Lost fiber cost = 1005 tons/yr * $445/ton =
$447,220/year
Filler loss:
1,500 tons/yr * 0.33 = 495 tons/yr
Filler cost = $161/ton
Lost filler cost = 495 tons/yr * S161/ton =
S79,700/year
White Water and Fiber Reuse
l.b. Fiber and Filler Loss (includes freight)
Estimated recoverable solids = 1,200 tons/year
Estimated solids loss = 1,500 - 1,200 = 300 tons/yr
Fiber loss:
300 tons/yr * 0.67 = 201 tons/yr
Fiber cost = $445/ton
Lost fiber cost = 201 tons/yr * 5445/ton =
$89,450/year
Filler loss:
300 tons/yr * 0.33 = 99 tons/yr
Filler cost = $161/ton
Lost filler cost = 99 tons/yr * $161/ton =
$15,940/year
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Current Process
1. RAW MATERIALS (cont.)
I.e. Freshwater Treatment
Annualized freshwater use = 1.5MMGD
Chemical Costs:
S/MG
Alum 0.025
Sodium aluminate 0.009
Polymer 0.034
Sodium hypochlorite 0.003
Total S0.071
1.5 MMGD * 365 days/yr *($0.071*1000)/MMG =
S38,870/year
White Water and Fiber Reuse
l.d. Freshwater Treatment
0.5MMGD freshwater > = $12,960
I.e. Flocculating Agents for Saveall
Avg. white water flow through saveall = 600 GPM
(864 MGD)
Chemical Costs:
Cationic polymer cost = $0.056/Mgal
Anionic polymer cost = S0.035/Mgal
total $0.091/Mgal
864MGD * S0.091/Mgal * 365 days/yr =
S28,700/year
2. UTILITIES
2.a. Freshwater Pumping
Annualized freshwater use = 1.5MMGD
Energy Costs:
S/period' S/MG
Variable freshwater pumping 133,098 0.234
Miscellaneous 1.479 0.0026
Total $134,577 $0.237
'period - 8 months, 1990
total freshwater use - 566,460 MG
1.5MMGD * 365 days/yr * ($0.237* 1000)/MMG =
$129,760/year
2.b. Freshwater Pumping
0.5MMGD freshwater > = $43,250/year
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Current Process
2.UTILITIES (cont.)
2.c. Freshwater Heating
1.5MMGD freshwater comes in at 57°F, must be
raised to 95°F
1.5MMGD * I Btu/lb°F * 8.4 Ib/gal * (95 - 57°F) =
4.788 x 10s Btu/day
Fuel cost (No. 6) = $0.39/gal
Estimated boiler efficiency = 82.5%
4.788 x 108 Btu/day * 1 gal No. 6 fuel/1.4 x 105 Btu
* S0.39/gal * 1/0.825 * 365 days/yr = S590,100/yr
White Water and Fiber Reuse
2.d. Freshwater Heating
0.5MMGD freshwater > = S196,700/yr
2.e. Wastewater Pumping
4.0MMGD * 365 days/yr * S150/MMGD
$219,000/yr
2.f. Wastewater Pumping
3.0MMGD > = $164,250/yr
2.g. Wastewater Treatment
Average, annualized wastewater discharge rate =
4.0MMGD
Wastewater treatment cost = S187/MMG
4.0MMGD * 365 days/yr * S187/MMG =
S273,020/yr
2.h. Wastewater Treatment
3.0MMGD > = S204,760/yr
2.i. Energy for Equipment Operation
Electricity cost = $0.08/kWh
New Equipment HP
Drive Pump 1
Scoop Pump 1
Pressure Pump 40
Feed Pump 20
Recovered Stock Chest Agitator Motor 5
Recovered Stock Chest Pump 25
Clear White Water Chest Pump 125
White Water Surge Pump 125
Total 342 HP
342 HP * 0.6 * 0.746 kWh/HP * 8.760 hr/yr
S0.08/kWh = $107,280
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Current Process
3. LABOR
White Water and Fiber Reuse
3.a. Equipment Operation - Saveall
4 hours/week labor
$15/hour - fully loaded wage rate
4 hrs/week * 52 weeks/yr * S15/hr = S3,120/yr
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REVISED EXECUTIVE SUMMARY
JUNE 1993
ALTERNATIVE APPROACHES TO THE FINANCIAL
EVALUATION OF INDUSTRIAL POLLUTION
PREVENTION INVESTMENTS
Prepared for:
New Jersey Department of Environmental Protection
Division of Science and Research
Project No. P32250
By:
Allen L. White, Ph.D.
Deborah Savage, Ph.D.
Monica Becker
Risk Analysis Group
Tellus Institute
11 Arlington Street
Boston, MA 02116-3411
Tel: 617-266-5400
Fax: 617-266-8303
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PREFACE
This Executive Summary supercedes a version originally published in a November 1991
report to the New Jersey Department of Environmental Protection entitled: Alternative
Approaches to the Financial Evaluation of Industrial Pollution Prevention Investments.
This revised version includes changes to the text for purposes of clarification and completeness,
as well as new results of the financial analysis of three pollution prevention projects. The latter
changes reflect both refinements to the analytical tool used in the original profitability analysis
and the availability of new data on the costs and savings of the projects themselves.
Taken together, the three revised analyses reinforce the central finding of the original
study ~ that improved managerial accounting systems, including accurate measurement and
allocation of both physical and cost aspects of waste generation, are essential for achieving a
clear, unbiased perspective on the profitability of industrial pollution prevention investments.
BACKGROUND
Both regulatory and market forces are moving firms to re-think their pollution
management practices. Regulatory pressures in the form of pollution disclosure requirements,
bans on land disposal of many hazardous wastes, escalating waste disposal costs, bans or
limitations on the use of certain hazardous materials and other federal and state mandates act
as strong inducements to prevent rather than control pollution. Reinforcing these pressures are
market incentives, some created by government ~ e.g., tradable permits and taxes on hazardous
waste - and others by public and consumer demand for clean technologies and "green"
products. When these regulatory and market forces are taken together, the prevention path
should look increasingly attractive to companies from the standpoint of both compliance and
market competitiveness.
Despite these trends, however, the pace of conversion to a more preventive mode of
environmental management has been slow, and many seemingly profitable pollution prevention
opportunities remain unexploited. If such investments are in the best interests of a profit-
driven firm, why does such underinvestment in prevention persist? The answer is arguably
two-fold: (1) organizational: characteristics of the firm in the form of weak signals from top
management, failure to assign environmental managers adequate authority over capital
investments, and insufficient information flow to product design and operations staff to build
a broad constituency for prevention projects; and (2) financial: the inability of pollution
prevention investments to compete with other potential uses of limited capital because they are
disadvantaged by standard project evaluation techniques, and/or external and internal barriers
in the form of inaccessibility to capital for prevention investments.
Internal economic barriers, the focus of this study, are best assessed within the context
of a firm's capital budgeting process. Prevention projects compete with other demands for
scarce capital resources. Decisions on such projects and other candidate investments reflect
1
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a combination of financial analysis, qualitative assessments, and management instinct. Because
some economic returns to prevention projects tend to materialize in diverse and indirect forms,
and occur over a longer time horizon, conventional project analyses may underestimate or omit
altogether their returns to the firm. Such is the case, for example, when avoided liability,
reduced staff time for compliance, and enlarged market share owing to a "green" product image
are not incorporated into a project analysis. The result is that prevention projects as a group
may confront systematic bias in capital allocation decisions, resulting in potential chronic
underinvestment in such projects.
Total cost assessment (TCA) offers an alternative to conventional project analysis
approaches by extending the cost/savings inventory and time horizon, improving cost allocation
procedures, and using long-term profitability indicators. The effect of a TCA approach should
be to "level the playing field", such that prevention investments receive a balanced appraisal
by managers responsible for allocating capital resources.
For this study, ten firms of varying size and product lines were interviewed in Phase
I to determine the potential roles of, and receptivity to, TCA approaches in industry. In Phase
II three of these firms - a paper coating mill, a diversified chemical firm, and a metal
fabrication and finishing firm - cooperated in preparing in-depth project analyses using a TCA
approach. This approach builds upon earlier TCA methods while attempting to overcome a
number of weaknesses which have thus far hindered their adoption: unfamiliar and inflexible
costing format, lack of user-friendly software, and incompatibility with current company
practices.
In the context of the capital budgeting process, how do companies conduct project
financial analyses? How do these practices compare to a TCA approach? What effect does
TCA have on the estimated profitability of a pollution prevention investment? To answer these
questions we compare three aspects of current project analysis practices employed by the three
Phase II companies with comparable parameters of TCA analyses: financial indices, time
horizons and cost coverage. This is accomplished through the comparison of a "Company
Analysis" with a TCA for each of the three pending investments.
A brief description of the procedures used to develop the "Company Analyses" and the
TCA Analyses is in order. The development of project financial analyses was structured to
allow comparison between a TCA approach and that which had been previously used by the
three Phase II firms. Two steps were necessary. First, we needed to develop a baseline
financial analysis for each project, which we term the "Company Analysis". Each Company
Analysis consists of only those costs which had been included in the firm's evaluation of eithe'r
the complete project or components of the project thus far analyzed by the firm.
Since the prior financial analyses undertaken by the firms appear in numerous forms
and. in two instances, appear in several documents, we converted disparate information into
a uniform format to compare with a TCA analysis. To do this, we used a spreadsheet system
developed by Tellus to collect and organize capital and operating cost data, to calculate cash
-------
flow data and financial indices, and to perform sensitivity analysis to test the effect on financial
indices of various costing approaches.
COST INVENTORY
The comparison of the Company Analyses and the TCA Analyses solely on the basis
of cost inventory is relatively straightforward. We simply compare the capital, cash flow, and
financial indicators derived from the Company Analysis with those derived from the TCA
(Appendix B). This single dimension comparison shows the impact of an expanded list of
costs and savings on the financial indicators for the project.
While cost categories in a financial analysis tend to differ according to the nature of the
project, we can infer from the Phase II Company Analyses the types of costs typically
considered in project analysis. Table ES-1 presents the costs included in the Company
Analyses and the TCA Analyses.' The TCA column represents a complete picture of the
internal costs and revenues affected by the project. By comparing the Company Analysis
column with the TCA column, a picture of the firm's project costing approach emerges.
Direct and Indirect Costs. In the case of Project 1 (Table ES-1), the Paper Coating
firm omitted all non-disposal waste management costs, utilities (energy, water and sewerage),
solvent recovery, and regulatory compliance costs from its analyses of the aqueous conversion
project. The firm also omitted several costs associated with the storage needs and shorter shelf
life of aqueous coatings; namely a steam heating system for the coating storage shed, lost raw
material value, and cost to dispose of spoiled coating.
The Metal Fabrication Company (Project 2) did not include installation and training in
its capital estimate for the paint/water separator, and omitted waste hauling and hauling
insurance, water, and sewerage costs from the annual operating cost estimate. While the firm
considered the avoided cost of disposing of the paint/water and oil/water waste, it did not
include the cost to dispose of the sludge generated by the separator.
The financial analyses developed by the company for Project 3 were extremely detailed
and comprehensive. Since the waste stream targeted for recovery is not a RCRA waste, it is
not subject to manifesting, monitoring, reporting and other regulatory requirements. Therefore,
we can not infer from the Company Analysis whether regulatory or non-disposal waste
management costs are normally considered by this firm.
1 In the case of Project 2, labor costs were explicitly considered by the firm but were not
quantified because they would not be affected by the project. Therefore, we have checked off
labor costs in both the Company and TCA columns.
-------
Future Liability Costs. We focus on two general forms of future liability costs-
liability from personal injury or property damage (e.g., Superfund liability stemming from a
leaking landfill), and penalties and fines for violation of environmental regulations. None of
the companies for which in-depth project studies were completed included an estimate of
avoided future liability costs in their financial analyses. In the case of Project 1 the Paper
Coating firm indirectly alluded to this benefit in a qualitative way in its Appropriations
Request: "...major reductions in levels of fugitive emissions, and amounts of solid hazardous
waste going to landfill, is very positive from a regulatory and community standpoint".
The Metal Fabrication Company did not include an estimate or mention of future
habi hty in its analysis of Project 2. By complying with state and federal hazardous waste
regulations and sending all waste to an incinerator, the Company believes it is safe from future
financial liabilities from fines, personal injury and property damage. In a previous project the
firm analyzed the direct economic benefits of a new paint procurement policy in light of a sta'e
regulation which contained a set of fines for improper shipping of hazardous materials Since
the Company was not meeting these requirements, the staff engineer clearly noted a potential
fine of up to $25,000 after two offenses. If incurred, the fine would far outweigh the long-
term savings in operating costs for the new system. The decision to suspend the new
procurement practice was based in large measure on the threat of fines.
. During the Phase I interview with the Diversified Chemical Company, we learned that
Company financial analysts are cautious in valuing indirect and intangible benefits of a project
-Instead, they choose to calculate only conventional, direct costs while leaving TCA-type
benefits such as avoided liability as qualitative inputs in appropriation requests. Although the
Company has developed a procedure for estimating costs associated with Superfund liability
d included neither an estimate nor mention of avoided future liability in any financial analyses
tot Project 3.
While none of the Phase I or Phase II firms include estimates of avoided future liability
in their quantitative project analyses, it is important to emphasize that our cases demonstrate
that liabihry avoidance is a major concern of companies. Many of the companies interviewed
are looking to pollution prevention to minimize the likelihood of liability associated with
hazardous waste generation. However, the availability of incineration as a disposal option to
some extent provides firms with a level of comfort which may act as a disincentive to pollution
prevention.
Less Tangibk Benefits. Less tangible benefits from pollution prevention investments
such as increased revenue from enhanced product quality, improved Company or product
image, increased worker productivity, and reduced worker health maintenance costs are among
the most difficult to predict and quantify. None of the three Company Analyses or TCA
Analyses contain estimates o^ less tangible benefits. In the case of Project 1, the coated paper
product is sold domestically, on the basis of cost, visual appearance, and performance
durability to book publishers aii-4 other intermediate product manufacturers. Although the
Company expects some quality improvements using aqueous coating, it does not anticipate an.
4,
-------
increase in market value. Therefore, it expects no increase in domestic sales as a result of the
conversion to the aqueous/heavy metal-free coating. However, the Company hopes to improve
its competitive advantage in the European market if the European Economic Community
implements an anticipated lead-free packaging standard which would apply to books.
However, it would not speculate on the potential revenue effects associated with increased
European market share.
Neither the Metal Fabrication Company nor the Diversified Chemical Company expects
to increase market share or product value as a result of Projects 2 and 3, respectively. Both
of these companies, as well as the Paper Coating firm, are manufacturers of intermediate, not
consumer, products. As such, they cannot directly market their products on the basis of
environmental attributes in the same way that a consumer products manufacturer can.
A reduction in solvent use at the Paper Coating firm will certainly reduce worker
exposure to fugitive solvent emission, and the elimination of nitrocellulose from the coating
mixture will reduce flammability and explosivity hazards. While reduced solvent exposure
may result in a lower incidence of worker illness over the long-term, and the elimination of
nitrocellulose may result in fewer worker injuries, we lacked adequate data to estimate the
potential impact of these benefits on either the Company's health care costs or long-term
worker productivity. In this case, this issue was dealt with qualitatively in a section of an
Appropriations Request called "Safety/Health Impact of Converting from Solvent to Aqueous
Coating".
Although many Company representatives noted that project benefits are more persuasive
if they are monetized and included in the project financial analysis, when costs are difficult or
impossible to monetize a qualitative approach may be more credible to management.
Discovery of previously omitted non-environmental costs. In developing the TCA
Analyses, we added to the Company Analyses any capital or operating costs or savings which
could be attributed to the project and reasonably estimated. While our focus was on
environmental costs typically omitted from project analyses, the process of developing a more
comprehensive list of costs unearthed, in the case of Projects 1 and 2, other, "non-
environmental" costs not originally included by the Company. For example, in Project 1, all
previous analyses of the aqueous/heavy-metal free conversion ("aqueous coating conversion")
omitted the costs of heating system installation, the energy needed to prevent the aqueous
coating from freezing, and the additional energy needed to dry aqueous versus solvent-based
coating. While the latter cost was acknowledged by several production engineers and managers
in1 meetings with Tellus, it had never been estimated nor included in previous analyses. In the
case of Project 2, equipment installation and operator training costs (while admittedly small)
were not included in the Company's initial analysis. These items, which tended to increase the
cost of the prevention project, were included in the TCA Analysis. Thus, the TCA Analyses
of Projects 1 and 2 illustrate that non-environmental. direct and indirect costs may also be
omitted project analyses.'
-------
FINANCIAL INDICES
Financial indicators are used as a critical, though not exclusive, decision marker in
analyzing pollution prevention projects. Firms typically use such indicators as auidenosts
rather than decisive elements in judging the merits of a proposed project. Their application
tends to be flexible, that is, subject to substantial management discretion as proposals move
through the formal or informal budgeting process and compete with one another for scarce
capital.
The choice of financial indicators to assess project performance ranges from the simple
single-indicator evaluative process used by most small firms to a two or more-stage process
among larger size firms which often use several indices, For the former, simple payback is
dominant. For the latter, payback (or slightly more sophisticated ROI) is typically used as a
first screen. If a project passes a prescribed hurdle rate, a more in-depth analysis using NPV
and/or IRR is common. - .
In our study, the Auto Radiator Shop and the Electroplating Company, both small firms
use a simple payback calculation to evaluate projects. If a project meets or exceeds a hurdle
rate of 1-2 years and 1 year, respectively, the project is considered profitable The
Refrigeration Company, a medium-sized firm, looks favorably upon projects with a 2-3 year
payback. In none of these cases is the hurdle rate inflexibly applied. Instead, the project's
place in the strategic thinking of top management and external pressures from customers
regulators, and the community help define how rigidly the hurdle rate will be used in judging
a project's desirability. J & &
The Paper Coating Company and the Diversified Chemical Company, both large firms
use an ROI to sc:een proposed projects before subjecting them to more in-depth NPV and IRR
analyses. Tfo.s practice provides the project proponent with an informal estimate of expected
.performance prior to investment of staff resources (and personal capital) in advocating an
investment. Once the ROI milestone is passed, the proposal typically moves into a divisional
or sectoral review where more sophisticated calculations are developed to capture longer-term
costs/savings.
TIME HORIZON
Time horizon, of course, is closely tied to financial indicators. By nature, payback and
ROI calculations are not capable of capturing long-term costs/savings, a serious shortcoming
in the case of liability estimation where costs (and cost avoidance) may materialize 10 years
or more into a project's lifecycle. NPV and IRR, on the other hand, both account for future
years costs/savings. Their use is common in large firms and large investments whose market
and budgeting horizons, are extended and who are financially capable of waiting many years
for an investment'to break-even and begin tuning a positive cash flow.
-------
Though the small companies studied may qualitatively consider the long-term benefits
of pollution prevention investments, their use of simple payback as the primary or sole
indicator of an investment's return reflects their short-term financial perspective. The Paper
Coating and Diversified Chemical Companies indicated that a time horizon pf 10 years is
typical for evaluation of major investments. In the case of the Paper Coating Company, the
need for extending this figure to 15 years to capture estimated liability avoidance for the
project analyzed became evident in preparing the TCA analysis.
RESULTS
In two of the in-depth analyses, the inclusion of waste management, regulatory
compliance, future liability and other previously unquantified costs in the TCA Analyses
resulted in a net improvement in project cash flows and financial indicators as compared to the
Company Analyses. Table ES-2 summarizes these results.
The magnitude of the effect, as illustrated by the percent change in IRR (years 1-15) ranged
from a low of-5% for Project 1 to 3% for Project 2. The 15-year NPV difference is more
dramatic, extending from a low of -94% for Project 1 to a high of 33% for Project 2. Only
in the case of Project 2 are the financial indicators noticeably improved by the TCA; payback
is reduced from 4.3 to 3.8 years and the 15 year NPV is 33% higher than for the Company
Analysis. The degree of change was determined principally by the cumulation of annual
operating costs and benefits added to the TCA, and, to a lesser degree, the addition of capital
costs which were not accounted for in the Company Analysis. With respect to future liability,
the impact of this cost on a financial indicator depends on the size of the estimated liability,
the projected year in which it will occur, and the discount rate used in the calculation of NPV
and IRR.
Consider the results for Project 3, for which only NPV changed significantly. We see that
much depends on the original capital cost of the project, the completeness of the company's
own analysis, the magnitude of indirect savings, and when such savings occur. And,
surprisingly, as illustrated by Project 1, TCA is as likely to turn up additional costs as savings,
which can actually diminish the attractiveness of the prevention investment to the firm!
Moreover, the effort expended in preparing the TCA analysis, though partially attributable to
startup costs of any new practice, was substantial enough to make even large firms weary of
adopting such an approach for all projects competing for capital resources.
The limited number of cases included in this study precludes generalizations about
overall corporate receptivity to TCA approaches and the degree to which pollution prevention
will be accelerated by its adoption. In general, we adopted a conservative approach in this
study, in the sense that only the most obvious and quantifiable costs were incorporated in the
TCA analyses. Thus, the gains from applying a TCA versus a company approach should be
regarded as low range estimates. Within the limitations of our study, however, it is clear that
TCA can serve as a valuable tool for translating discretionary judgements into concrete dollar
-------
values during the capital budgeting process. Insofar as pollution prevention projects are
particularly prone to less tangible and indirect costs and benefits, TCA equips managers to
develop a more precise estimation of the real financial returns to such projects. Though TCA
does not a priori ensure an attractive profitability level for prevention projects, the cost
characteristics of such projects suggests that their financial performance in general will be
enhanced by TCA. This is likely to be particularly true for industrial prevention projects that
are materials and process-focused, and occur upstream in the production process. Over the
longer term, TCA could serve as a substantial force in. transforming the "must-do" and
"inherent loser" image of environmental projects into a more positive, profit-adding and
market-expanding image.
Inducements to TCA adoption may take the form of incentive, educational, or training
programs. Incentive programs may include expediting facility permitting for those firms which
adopt and demonstrate the application of TCA methods beyond the requirements contained in
the recently enacted New Jersey Pollution Prevention Act. TCA training seminars, with
specialized modules aimed at large, medium and small-sized firms, may be offered by DEPE.
These programs may be offered in conjunction with trade and business associations, and
customized to a particular industry or product-line where appropriate. In addition, expanded
direct assistance to individual managers, of the type currently offered by the New Jersey
Technical Assistance Program, may be offered as follow-up to such seminars.
To supplement incentive programs, mandatory pollution prevention plans required under
the Pollution Prevention Act set forth minimum cost and benefit items for inclusion in project
financial anslyses. Firms must justify why a financially viable prevention projeci is not
undertaken. The aim is to catalyze corporate self-interest in pollution prevention by-
demonstrating profitable opportunities which might otherwise go unnoticed or underestimated.
Even with such demonstration, of course, prevention investments cannot be assured since
bottom-line financial indicators are but one among several determinants of allocation decisions
within a firm's capital budgeting process.
Finally, while a particular TCA method is not a prerequisite to the adoption of a
pollution prevention approach, a user-friendly method can simplify and expedite the analysis
and comparison of projects. No one TCA method is suitable for all firms. A successful
strategy will present firms with a menu of tools from which to choose. Such methods may
include those previously developed, the P2/FINANCE method developed for this study, or
modification of existing analytical fools currently used by individual firms.
Choosing among TCA promotion strategies must flow from broader policy positions
affecting how vigorously the state wishes to be involved in shaping the capital" budgeting
process which is traditionally viewed as the sole prerogative of the firm. Regardless of how
aggressive a state program is, the success of TCA ultimately depends on the degree to which
managers believe that TCA is, above all, an aid to greater profitability in business operations.
-------
Table ES-1. Cost Inventory: Company Versus TCA Analyses
X » Costfs) Included Project 1'
P ** Costfs) Partially Included Company
Capital Costs
Purchased Equipment X
Materials (e.g. Piping, Elec.)
Utility Systems
Site Preparation
Installation
Engineering/Contractor X
Start-up/Training X
Contingency
Permitting
Initial Chemicals
Working Capital
Salvage Value
Other:
Project Audit
Operating Costs
Direct Costs:4
Raw Materials/Supplies P
Waste Disposal P
Labor X
Revenues - General
Revenues - By-products
Other
Transportation
Indirect Costs:5
Waste Management
Hauling
Storage
Handling
Waste-end Fees/Taxes
Hauling Insurance
Utilities
Energy
Water
Sewerage (POTW)
Pollution Control/Solvent Recovery
Regulator)' Compliance
Insurance
Future Liability
Notes:
X
X
X
X
X
X
X
X
X
X
X
X
Project 22
TCA Company
X X
X
.X
X
X
X
X
X
X
P
X
X
X
X
X
X
X
X
X
X
Project 33
TCA Company
X
X
X
X
X
X
X
X
X
X
TCA
X
X
X
X
X
X
X
X
X
X
X
1.
2,
3.
5.
Solvent/heavy-metal to aqueous/heavy metal-free coating conversion at Paper Coating Company
Paint/water separator at Metal Fabrication Company
Byproduct recover)' project at Diversified Chemical Company
We use the term "direct costs" to mean costs which are typically allocated to a product or process line (i.e.
not charged to an overhead account) and are typically included in project financial analyses.
We use the term "indirect costs" to mean costs which are typically charged to an overhead account and
typically not included in project financial analyses.
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Originally presented at the 1995 TAPP1 International Environmental Conference May 7-10 Atlanta GA
Copyright TAPP1 1995
ENVIRONMENTAL ACCOUNTING:
PRINCIPLES FOR THE SUSTAINABLE
ENTERPRISE
A.L. White, Ph.D.
Senior Scientist
TeUus Institute
Boston MA 02116
A. Dierks
Research Analyst
Tellus Institute
Boston MA 02116
ABSTRACT
D.E. Savage, Ph.D.
Research Associate
Tellus Institute
Boston MA 02116
Three case studies from large manufacturing firms illustrate
the importance of good environmental cost accounting in
the realm of project financial analysis for capital budgeting.
The environmental projects described encompass capital
budgeting initiatives on three levels: 1) Jhe facility level;
' 2) the divisional level; and 3) the corporate: level.
Although the original motivation for each cast study was
recognition of the need for a comprehensive, accurate
capital budgeting analysis for the environmental proposal
under consideration, two of the analyses also identified aad
quantified, in dollar terms, the strong connections that exist
between environmental projects and broad issues of
integral interest to firms, such as production flexibility and
capacity, and environmental liabilities. As such, these
studies provide valuable insights into the scope, sources,
and application of environmental cost information within
the firm, and how improvements in each of these areas can
play an important role in supporting rational management
decision-making.
Key conclusions emphasize the necessity for good
materials accounting as a basis for good cost accounting,
and the importance of adequate treatment of probabilistic
MEASURING TO MANAGE
Industry managers face a disturbing and growing dilemma
when it comes to environmental costs. On the one ,hand,
regulatory requirements, voluntary standards, and market
pressures continue to impose continually higher, and more
costly, demands for environmental excellence. On the
other hand, the information essential ,-to fashioning a
rational response to such expectations is typically
unavailable in a timely, rigorous, and consistent way. The
result: decisions on capital projects, materials choices,
product pricing, and product mix often serve neither the
best interests of the firm nor, in many cases, the
environment.
What are the root causes of this dilemma? At least four
are identifiable, linked to both the nature of traditional
.accounting systems and the nature of environmental costs
themselves.' First, traditional accounting systems are
geared partly to compiling and preparing information for
external reporting and disclosure, e.g. annual reports to
stockholders or 10-K filings to the Securities and Exchange
Commission (SEC). In serving to profile the overall
financial performance in a digestible form while protecting
competitive information, such information must be
aggregated. For industry managers charged with
environmental performance, as well as day-to-day or
month-to-month production, pricing, and product mix
decisions, conventional aggregated financial information is
of minimal value.
Second, many environmental costs traditionally have been
lumped into pooled, or overhead, accounts that are
detached from the products and processes responsible for
• creating costs in the first place. When costs are uncoupled
from the activities that generate them, managers are faced
with incomplete or distorted information which cannot help
but k,ad to suboptima! decision-making. Of course, unless
incentives for improved cost allocation are put in place,
shifting pooled environmental costs to specific products
and processes may be unwelcome to managers who
suddenly see a product line looking less profitable than
otherwise thought.
Third, many environmental costs are contingent and subject
to substantial margin., of errors.2 These attributes are not
unique to environments! costs, but it is fair to say that
-------
environmental costs often represent the extreme case in
comparison to labor, equipment, materials and other more
certain items which comprise the manager's cost calculus.
Liability in its various forms — Superfund, property
damages, natural resource damages — is the classic case.
In the normal course of business planning, such costs arise
only when something goes wrong and the firm is deemed
liable by a regulatory body or court of law. If and when
such costs materialize is difficult to predict with any
degree of reliability. Yet to pretend they do not exist, or
never will, is neither acceptable to the SEC nor prudent
practice for the responsible manager. Liability is not alone
among environmental costs in this regard. Future
regulatory compliance costs, revenues generated through
tradable permits for criteria or air toxic pollutants, and
shutdown costs owing to sudden environmental releases are
other examples of environmental costs whose timing, and
magnitude are equally difficult to assess.
Fourth, the foundation of an accounting system capable of
delivering useful environmental information to managers is
a sound system of materials accounting. Distilled to its
basic element, environmental management in
manufacturing industries is about materials management -
materials use, processing, release into the environment, and
final disposition or reclamation once the useful life of a
product is ended. At each step of the product cycle, these
activities may result in costs via low yields or other forms
of production inefficiencies, the costs of effluent and
emissions controls and prevention, Superfund and product
liability costs, and other less tangible, hidden, or indirect
costs. In this fashion, the sibling relationship between
materials accounting and cost accounting lies at the heart
of effective environmental management, and is integral to
shaping the next generation of accounting systems
supportive of corporate environmental improvement goals.
Unfortunately, the implications of this critical linkage
normally does not receive the recognition or follow-up it
deserves.
EXAMPLES FROM CAPITAL BUDGETING
The measure of quality of any accounting system is how
effectively it delivers information to the users for the
purposes for which it is designed. Environmental
accounting is no exception. It is simply the application of
sound accounting practices to decisions which are. to first
order, inherently environmental — e.g. how best to reduce
air toxic emissions ~ or. alternatively, are not primarily
environmental but contain a significant environmental
dimension — e.g. the decision to relocate and consolidate
the production of intermediate materials when such a
decision will enable both production efficiencies and cost-
effective waste management opportunities. Thus, by this
definition, environmental accounting serves a wide range
of management decisions, including: determining optimal
product mix and process designs; assessing the priorities
and economics of waste management and pollution
prevention options; benchmarking environmental
performance at the same facility over time, across facilities,
or in relation to industry-wide performance; and bringing
true costs to bear on pricing decisions.
Recent case studies of capital budgeting of environmental
projects among large U.S. firms demonstrate some of the
shortcomings of conventional accounting practices and
directions for their improvement. We illustrate by
considering projects at three levels: (1) the facility level;
(2) the divisional level; and (3) the corporate level. These
examples provide valuable insights into the scope, sources,
and applications of environmental information, and how
improvements in each of these areas plays a role in
rationalizing management decision-making.
Facility Level
The first case is drawn from experience at a specialty paper
mill, which produces a variety of uncoated, on-machine
and off-machine coated papers, carbonizing, book and
release base paper.3 The coating used is a latex (i.e. non-
solvent) formulation containing clay, styrene butadiene,
starch, and polymers. The case study compared a typical
Company financial analysis with a more comprehensive
Total Cost Assessment (TCA) of the proposed project.
TCA is an approach to capital budgeting for environmental
projects that comprises four elements: (1) an expanded
inventory of costs, savings, and revenues to capture less
tangible and indirect effects of an environmental
investment; (2) allocation of costs to product or process
lines instead of overhead accounts; (3) expanded time
horizons for purposes of estimating profitability; and (4)
use of appropriate and multiple financial indicators to
accurately characterize project profitability.
Papermachine white water, a mixture of water and residual
fiber and filler (clay and calcium carbonate) that drains out
of a sheet of paper as it travels across the paper machine,
is typically captured by a white water collection system
dedicated to a single papermachine. As a pollution
prevention measure to reduce water use and wastewater
treatment, white water may be passed through a saveall
screening device to separate fiber and filler from water;
fiber, filler and water are then recycled back into the
-------
system. The saveall produces a clear stream of water that
. can be used in numerous papermachine operations.
In this mill, two paper machines, sharing a common white
water system, produced a variety of paper grades made
with either acid, neutral, or alkaline sizing chemistry."
[Machine 1 had a saveall system that filtered fiber and filler
prior to discharging into the joint white water system. This
material was recycled back into the papermaking system.
When the machines were using different sizing chemistry,
the mixed white water from both machines was not
reusable, and had to be sewered. Under these conditions,
a large flow of potentially reusable water from both
machines, and fiber and filler from Machine 2, was lost to
the sewer.
Prompted primarily by the lack of spare water effluent
pumping capacity, the mill commissioned a study to better
understand the white water piping system. The resulting
report contained detailed engineering drawings of the fresh
water, white water, and paper machine systems and two
recommendations for process modifications.
The first recommendation was the installation of a second
saveall to capture fiber and filler from Machine 2. Under
the second recommendation, the white water systems
would be split, so that each machine would have a
dedicated system. This would require installation of i new
pump, piping, and controls. In combination, these system
modifications would permit fiber, filler and water reuse an
both machines at all times and would minimize Biological
Oxygen Demand (BOD) and solids in plant wastewater.
Company Analysis consists of the required capital
costs and only those operating costs and savings that the
company typically includes in project financial analyses for
projects of this type. The TCA contains these and other
operating costs and savings, which were developed in the
course of the case study. In this white water/fiber reuse
• project, a number of cost items appear in the TCA which
are either partially or entirely omitted from the company
analysis. These include savings in raw material costs
owing to recovery of fiber and filler; a savings in fresh
water usage and costs, and associated fresh water treatment
and pumping; a savings in energy use for fresh water
heating; and a .savings in wastewater pumping and
wastewater treatment fees.
-Table I shows the financial impact of the omitted savings
by comparing the Company and TCA profitability analyses.
This project, with a capital cost of SI.47 million, yields an
annual savings of S350.670 with the Company Analysis,
versus $911,240 in the TCA. Net Present Value (NPV)
over a 15-year time horizon jumps from $360,301 to $2.8
million. And Internal Rate of Return (1RR) over 15 years
increases from 21% to 48%. At the same time, the
payback period declines from 4.2 to 1.6 years.
The project did not affect wastestreams that require on-site
management or disposal, nor did it affect any regulatory
compliance activities at the site, therefore the financial
analysis did not include costs for these activities. In
addition, no impacts on revenue were expected since
neither product quality nor production rates would be
improved, nor did the mill expect to visibly enhance its
product or company image. Finally, no tangible impact on
avoided future liability was expected for this project. In
sum, the TCA/Company differential in profitability
occurred in a pollution prevention project involving a
relatively straightforward, proven technology, and was
substantial even without inclusion of some of the more
indirect, less tangible financial benefits that may well occur
with more complex and hazardous production technologies.
Table I. Summary of Financial Data for White Water
.and Fiber Reuse Project
Company 'Analysis TCA
Capital Costs $1,469,404 - $1,469,404
Annual Savings $ 350,670 $ 911,240
Financial Indicators
•NPV Years 1-15 $ 360,301
IRR Years 1-15 21%
Simple Payback (years) 4.2
$2.851,834
48%
1.6
Divisional Level
.This case study was performed for the chemical
manufacturing operations of a multinational high
technology firm and illustrates the integral connection
between pollution prevention and general production issues
such as production planning, capacity, and flexibility at the
division's two major facilities.5
The project involved the financial analysis of the costs and
benefits of completing a batch still solvent recovery
system, which was halted mid-way during construction
because of cash flow constraints. During the construction
delay, which lasted several years due to ongoing
competition for capital funds, facility production "plans
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changed, clouding the question of how many waste streams
on site would be suitable for batch still recovery. This
uncertainty in the annual raw material and waste disposal
savings resulting from an on-site recovery still, in addition
to the elapsed construction down-time, made it necessary
to revisit the original financial analysis of the project
before management approval for still completion could be
sought.
As in the prior facility level case, we again approached the
project analysis using a TCA framework: a comprehensive
cost/benefit inventory, accurate cost allocation to the
production processes involved, a long analysis time horizon
(12 years), and use of financial indicators which take into
account the time value of money. The issue of the time
value of money was particularly relevant to this project
because of the significant delays in completion of project
construction. P2/FINANCE, a spreadsheet software tool
developed earlier to handle pollution prevention project
financial analysis, was modified to handle these delays.
Capital costs were relevant to both of the final decision
options of 1) canceling the project permanently and
writing-off and depreciating the previously expended funds
and 2) approving project completion, which would require
new capital expenditures.
The firm's environmental staff requested a special focus on
the issue of cost- inventory and the possibility of
quantifying less tangible items such as future waste
disposal costs and potential liabilities, items often omitted
or left unquantified in project evaluations. We investigated
the implications of these issues to project profitability by
mapping all of the waste streams designated for the batch
still from production to final fate. The fates of these
streams included treatment by multiple, sequential vendors
and some landfill disposal in both the U.S. and Canada.
After this exercise, it became clear that, with one
exception, most waste management costs — transport,
treatment, disposal, as well as manifesting and related on-
site activities — were not significant enough to materially
affect project profitability. Rather than spend additional
staff resources on refining estimates of such costs, and
potentially diverting upper management's attention away
from a more critical issue in its decision-making, we
decided to terminate efforts at further quantifying waste
management and liability costs.
The more critical issue to project justification was the
effect of the proposed project on production capacity and
flexibility, the full impact of which only gradually became
evident during the course of data development.
Specifically, a major intermediate product, which is usually
purchased from another firm, was being considered for on-
site production, either at the batch still site or at another
company site in the same state. Consideration of the
several waste streams from this potential production line
(cumulatively called Stream X in Figure 1) had a
significant effect on the financial analysis of the batch still
project. The base case Internal Rate of Return (1RR)
increased from approximately 4% to 21% upon inclusion
of these waste streams. Moreover, company staff did not
consider adoption of the new production process to be
feasible in the absence of a solvent recovery system that
would reduce production costs via waste disposal savings
and raw material recovery.
Further complicated by air emission regulations and
technical issues, solvent still capacity limitations at the
second production site, and production technical
uncertainties, the final analysis of the batch still evolved
into a series of financial scenarios. As illustrated in Figure
1, the scenarios represent different configurations of
product mix (and therefore wastestream mix), production
sites, waste stream fate in the absence of a batch still, and
levels of future capital expenditure required for project
completion. These scenarios serve to pinpoint major
decisions facing division management, particularly in the
area of production planning. How much, where, and when
should production of intermediate chemicals occur?
Convinced of the integral role of the solvent recovery-
system in such planning, the environmental and production
staff, in almost unanimous support of the project,
proceeded to resolve production and other uncertainties in
preparation for the funding approval process. The
questions raised by scenario analysis, and the substantial
staff effort spent on answering them, eventually paid off.
In December 1994, upper management approved funding
for completion of the batch still project.
Corporate Level
Our third case centers on an issue at the forefront of
management concern for more than a decade: the
characterization, measurement, and reduction of liability.
Yet, as is often the case in environmental accounting,
initial perceptions of key management issues are
transformed during the course of cost identification and
analysis. In this instance, such an evolution occurred as
production shutdown costs associated with a transformer
fire or spill emerged as a second significant contingency
cost in addition to the usual liability costs for Superfund,
personal, and property damages.
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Our case involved the environmental division of a large
manufacturing firm, which was seeking to implement an
accelerated corporate-wide PCB transformer phase-out
•. program. The proposal was not a new one; earlier
initiatives to obtain funding for this project did not succeed
because of the staffs inability to justify the project on
financial grounds. Because the project would require tens
of millions in capital to replace all PCB transformers
within a five year accelerated time frame (versus an
otherwise expected time frame of 30 years), upper
management required financial justification beyond what
had been put forward in earlier appropriations requests.
In an earlier analysis of a similar PCB phase-out proposal,
the liability costs associated with retaining PCB
transformers on-site were based on a report by the U.S.
Army Corps of Engineers6, which assumed as one of its
costs a catastrophic failure cost of $85,000 for each
transformer in its fortieth year of service. These costs
were the source of much contention during the previous
capital budgeting cycle; many employees questioned the
accuracy of these liability costs and therefore the validity
of the capital request. Due to this earlier debate,
management decided to invest substantial effort in the
development of defensible liability costs. These, then,
were the focus of our analysis.7
Two approaches that may serve as the basis for cost and
probability estimates are engineering and actuarial
techniques. Engineering-based liability estimation uses a
model in which the estimated failure of each component in
the system yields a risk of an event (e.g. the probability of
failures of component X, Y and Z in the factory chain
leading to a nuclear plant accident). On the other hand,
actuarial-based estimation uses a subset of historical
information relating to the event to calculate risk (e.g. the
annual number of nuclear facility shutdowns per total
number of facilities for the last ten years). By using
historical information for this case study, the defensibility
and accuracy of liability cost estimates is enhanced due to
the method's reliance on historical facts rather than
engineering (or theoretical) estimates.
We began thinking about liability costs by developing a
framework to incorporate the relevant costs, as shown as
Figure 2. By mapping the possible ramifications of an
acute event, one can begin to characterize the necessary
data and consider potential data sources. In this instance,
we determined that the most significant costs associated
with an acute event would be related to cleanup, litigation,
insurance, and business shutdown. For this case study we
considered two acute PCB events: a transformer fire and
a transformer spill. Separate data sets were developed for
these incidents owing to their different probabilities and
costs.
As shown in Figure 2, all of the costs associated with an
acute PCB event are contingent on the probability of that
event (A). For this study, the probabilities of a transformer
fire and spill were developed from historical databases .and
equal 0.000018 and 0.0034 events per transformer-year
respectively8. Each acute event requires some cleanup,
with an associated cost (B) equal to approximately $7.8
million for a transformer fire and $100,000 for a
transformer spill. Mediating these costs by the probability
of the event's occurrence leads to an annual cost per
transformer year of $140 for a transformer fire and $339
for a transformer spill9.
Beyond cleanup, an acute event leads to the potential for
third party litigation (C) and its associated cost. For this
cost item, historical information10 was combined with
internal (i.e. company) estimates to generate the following
annual costs per transformer-year: $68 for a transformer
fire and $3,213 for a transformer spill.
Further, an acute event or third party litigation may lead to
increased insurance costs (D) for the firm. Thus, insurance
effects may be a function of three probabilities (i.e.
probabilities of event, litigation and insurance effects). In
this case study, insurance costs were not likely to be
impacted by third-party litigation because the firm was
self-insured and therefore were not considered further.
As vrs proceeded with an assessment of liability costs, a
second cost implication emerged -- production shutdowns
or slowdowns owing to interruptions in the flow of
intermediate inputs in the firm's vertically-integrated
production chain. Losing even one day of production
could trigger a significant loss of revenues to the firm if it
results in a loss of sales output or significant costs to make
up that production.
These shutdown costs, depicted in Figure 3, depend on the
firm's production level, inventory, worth of output, etc.
They are measured by the probability of the acute incident,
the probability that this incident results in lost production
and the cost of the shutdown per day. After facilities that
depend on inputs from the shutdown facility have depleted
their inventory, they too must shutdown, seen in Figure 3
as the secondary effects. These effects are characterized
by the probability that the primary facility is depended
upon by secondary facilities, the number of secondary
facilities, plus a measure of the inventory available to the
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secondary facilities. For this case study firm, the shutdown
cost of a transformer fire equals S10 per transformer-year,
whereas the shutdown cost of a transformer spill equals
SI,560.
Aggregating all of the costs (i.e. cleanup, litigation, and
production effects) associated with acute incidents, gives
the total costs associated with acute incidents, as show in
Table II.
As an example, the above totals indicate that a firm using
200 PCB transformers could save $1,066,000 annually in
contingent costs if it replaced those PCB units. These
contingent costs reflect the firm's liability, or risk, of
continuing to use PCB-containing transformer units.
Although it is impossible to definitively assess a firm's
liability (e.g. a transformer fire could happen in the current
year or it could never happen), actuarial-based liability
estimation aids management in planning for the future by
incorporating reasonable estimates of contingent costs.
Table II. Total Contingent Costs Per Transformer-
Year Associated with a PCB Transformer
* Total cost of transformer fire
• Total cost of transformer spill
cost per unit-year
$ 218
5,112
LESSONS LEARNED
What lessons may be culled from our three case studies?
Are there themes that emerge that may inform future
initiatives in the design of environmental accounting
systems, which are compatible with and serve to advance
the goals of sustainable development in corporate
environmental management? Our case studies are limited
to only one function of environmental accounting, namely,
decision support of project profitability analysis in the
context of capital budgeting. As we noted at the outset,
many other functions are served by environmental
accounting, e.g. product mix and pricing decisions,
monitoring and performance evaluation, and the design of
incentive systems to encourage environmentally-innovative
behavior among staff. Notwithstanding our focus on the
project evaluation function, we point to several themes that
may assist in the design and/or modification of corporate
accounting systems to support environmentally-wise
decision-making.
1. Effective cost accounting requires effective materials
accounting. This point, noted in our opening observations,
cannot be overstated. Environmental costs arise when
hazardous materials are used, processed, and/or released as
non-product outputs, and understanding material flows as
they move through a production system is a prerequisite to
identifying and tracking environmental costs. Mass
balances are the most rigorous basis for developing such
information, but short of this, materials accounting and
process flow diagrams may well suffice. As the first case
study of the paper firm amply demonstrates, a single
omission or error in defining relevant materials or energy
flows can create major cost consequences that may lead to
misguided management decision-making. Moreover, as the
second (batch still) case study demonstrates, sound
materials accounting — in this case, tracking the flow of
different waste streams to their ultimate disposal site —
also serves as a useful screening device to avoid
unnecessary expenditures of staff resources on estimating
environmental costs that are relatively insignificant
compared to other project costs.
2. Key environmental costs are contingent in nature;
environmental accounting systems must be designed to
handle such contingencies. Cases 2 and 3 illustrate this
critical point. Many, perhaps most, "environmental costs"
are contingent, or probabilistic, in nature. They are driven
by future conditions or events with uncertain, but
estimable, probabilities and cost outcomes. Future
regulatory compliance and liability for Superfund, personal
or property damage are examples. Conventional financial
accounting practices are not designed to handle contingent
costs; in fact, contingencies are generally avoided in
financial reporting and where they do appear, are subject
to strict standards for estimation and disclosure (as in the
case of SEC rules). But such standards have little to do
with environmental costs for purposes of internal, decision-
making. Effective environmental accounting requires an
awareness of this critical difference and a willingness to
experiment with different methods for dealing with
contingent costs. Scenario analysis of the sort used in
Case 2 and actuarial-based cost estimation such as in Case
3 point to two approaches to handling the inevitable
uncertainties associated with environmental costs. Tools
such as these are an integral part of any environmentally-
conscious cost accounting system.
3. Improvements are likely to be incremental and
piecemeal. There is no single system that serves all
purposes in all firms. Those seeking such a definitive, all-
encompassing solution are likely to be disappointed.
Because environmental cost information serves so many
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different functions in the organization, the "system" is
better thought of as a set of adjustments to current cost
accounting systems, all with the purpose of identifying,
tracking, and reporting environmental information to
sharpen management decisions. In Cases 1 and 2, such
adjustments took the form of, respectively, more rigorous
process flow information and characterization of alternative
production systems configurations. Neither of these
required overhaul of existing practices, only greater
attention to detail and to bundling feasible "packages" of
where, what, and how much intermediate product
manufacture might occur. This amounted to nothing more
than sound management and engineering practices applied
to environmental projects.
4. Improved environmental accounting is not full cost
accounting. Our cases demonstrate an assortment of
initiatives to better identify and estimate internal
environmental costs to enhance project profitability
analysis. But internal costs are, by definition, limited to
those with measurable financial consequences to the firm.
They do not include environmental costs that accrue to
identifiable third parties or to society as a whole, such as
the cost of biodiversity loss owing to unsustainable forest
practices or wetlands loss, global warming owing to carbon
emissions, or forest, crop or building damages linked to
acid rain deposition. Full cost accounting in its strictest
sense would encompass such costs. While the direction of
environmental regulations and international accords and
standards is to extend the cost net outward to internalize
such external costs, few firms today are preparing to
voluntarily move in that direction. Although our cases
suggest that much work remains to get internal corporate
environmental costs in order, the anticipatory firm will
continuously look beyond such costs and design into its
managerial accounting system the capacity to track the full
range of environmental costs, both internal and external.
REFERENCES
1. Todd, R., "Zero-Loss Environmental Accounting
Systems", in B. R. Allenby and D.J. Richards (eds), The
Greening of Industrial Ecosystems, National Academy
Press, Washington, D.C., 1994, 191-200.
2. White, A., EPA Journal, "Accounting for Pollution
Prevention", July-September (1993), pp. 23-25; White, A.,
Becker, M., Goldstein, J., Total Cost Assessment-
Accelerating Industrial Pollution Prevention Through
Innovative Project Financial Analysis, With Applications
to the Pulp and Paper Industry, Prepared for U.S. EPA,
Office of Pollution Prevention, December 1991.
3. Excerpted from White, A., Becker, M. and Savage,
D.S., Pollution Prevention Review, "Environmentally Smart
Accounting: Using Total Cost Assessment to Advance
Pollution Prevention" Summer 1993: 247-259.
4. Sizing is added to pulp to reduce water absorbency in
the final paper. The Ph (i.e. acidity or alkalinity) of the
pulp must be adjusted according to the type of paper
desired and sizing used.
5. Savage, D.E., and White, A.L., Pollution Prevention
Review, "New Applications of Total Cost Assessment:
Exploring the Prevention - Production Interface", Winter
1995 (forthcoming).
6. U.S. Army Corps of Engineers. The PCB Transformer
System.
7. Data in the following discussion is modified as
appropriate for confidentiality reasons.
8. Information on the probability of acute PCB events was
collected from two sources: (1) the Emergency Response
Notification System Spill Database; and (2) an internally-
developed database on acute PCB-transformer events.
9. Cleanup costs were developed on the basis of two
sources: (1) Final Report for Task 1-04: PCB Spill
Cleanup Policy Evaluation by Alexa Fraser and Stephen K.
Dietz of Westat, Inc. in December 12, 1988; and (2) the
internal database on acute PCB-transformer events.
10. Litigation costs were developed using a subset of Jury
Verdict Research's personal injury database relatin" to
chemical exposure and industrial accident suits.
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Figure 1. Batch Still Scenarios
Typical past production schedule
Analysis time period: 12 years
Base Case
(Streams A,B,C)
NPV
IRR
-$1,441,000 + 4%
Payback
9.6 years
Stream A to Kiln
(Streams A,B,C)
-$ 756,000 + 8%
7.2 years
Reduced Capital
(Streams A,B,C)
-$ 88,000 +11%
5.7 years
Stream X
(Streams A,B,X)
+ $ 2,066,000 + 21 % 3.6 years
Combination of
Reduced Capital
and Stream X
(Streams A,B,X)
+ $3,419,000 +33%
2.1 years
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FIGURE 2. CONCEPTUALIZATION OF LIABILITY COSTS
P(acute event)
((Cleanup)
P * Probability of the event
$ = Cost associated with the event
P(3rd party litigation) * $(3rd party litigation)
P(insurance increase) * $(insurance increase)
FIGURE 3. CONCEPTUALIZATION OF SHUTDOWN COSTS
P(acute event)
Primary Effects
P(lost production 0 days, 1 day...n days) * $(shutdown/day)
After the nth day of lost production
Secondary Effects
P{lost production n+1 days, n+2 days...n+z days) * $(shutdown/day) * (# of primary
plants affected + (P(secondary plant) * # of secondary plants affected))
P s Probability of the event
$ = Cost associated with the event
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REVISED EXECUTIVE SUMMARY
JUNE 1993
TOTAL COST ASSESSMENT:
ACCELERATING INDUSTRIAL POLLUTION PREVENTION
THROUGH INNOVATIVE PROJECT FINANCIAL ANALYSIS
With Applications to the Pulp and Paper Industry
Prepared for:
U.S. Environmental Protection Agency
Office of Policy Planning and Evaluation
Office of Pollution Prevention
By:
Allen L. White, Ph.D.
Deborah Savage, Ph.D
Monica Becker
Risk Analysis.Group
Tellus Institute
11 Arlington Street
Boston, MA 02116-3411
Tel: 617-266-5400
Fax: 617-266-8303
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PREFACE
This Executive Summary supercedes aversion originally published in a December 1991
report to EPA entitled: Total Cost Assessment: Accelerating Pollution Prevention Through
Innovative Project Financial Analysis, With Applications to the Pulp and Paper Industry.
This revised version includes changes to the text for purposes of clarification and completeness,
as well as new results of the financial analysis of two pollution prevention projects in the pulp
and paper industry. The latter changes reflect both refinements to the analytical tool used in
the original profitability analysis and the availability of new data on the costs and savings of
the projects themselves.
In the case of Project 1, a white water and fiber reuse project in a coated/fine paper
mill, the revised analysis substantially strengthens the Total Cost Assessment in relation to the
Company analysis using three indicators of profitability. The revised analysis shows an
increase in Net Present Value (NPV, 15 years) from approximately $360,300 to $2,851,900;
Internal Rate of Return (IRR, 15 years) increases from 21% to 48%; and Simple Payback
decreases from 4.2 years to 1.6 years. In contrast, the revised analysis for Project No. 2, shows
a TCA analysis less profitable than the Company analysis, largely owing to substantial
increases in utility costs for operating an aqueous-based coating process. NPV decreases from
approximately -$203,600 to -$395,600; IRR decreases from 11% to 6%; and Simple Payback
increases from 7.6 to 11.7 years.
Taken together, the two revised analyses reinforce the central finding of the original
study ~ that improved managerial accounting systems, including accurate measurement and
allocation of both physical and cost aspects of waste generation, are essential for achieving a
clear, unbiased perspective on the profitability of industrial pollution prevention investments.
BACKGROUND
In its February 1991 National Pollution Prevention Strategy, EPA set in motion a series
of initiatives aimed at deepening and widening both government and private sector activities
in pollution prevention. Recognizing the inherent limitations of traditional "end-of-pipe"
approaches, the Strategy called for joint agency-industry action to redirect resources toward
elimination of pollutants instead of continued reliance on downstream, control-oriented
approaches that, while effective in solving one pollution problem, often create others. Without
a transition from control to prevention strategies, cross-media shifting of pollution among land,
water and air will continue, and reduction of pollution from dispersed, non-point sources will
remain extremely difficult to achieve.
For many firms, EPA's call for accelerated prevention served as a reaffirrhation of what
they already knew and,'to varying degrees, practiced—that in the medium and long-term,
pollution prevention generally is more sensible than pollution control. Early initiatives,
1
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beginning in the 1970's, were motivated by a simple .bottom-line consideration: continued
expenditures on pollution control investments to handle steadily increasing waste volumes
presented firms with the specter of an endless capital drain that would divert resources from
more lucrative opportunities in R&D, product development, manufacturing and marketing.
By the mid 1980s, other forces were encouraging the shift to prevention-oriented
strategies, including liability under the federal Superfund Act, public concerns with
environmental degradation, increasingly stringent pollution disclosure requirements, and widely
publicized industrial accidents in both the U.S. and abroad. As a result, firms have faced a
rising tide of public demands for shifts to clean technologies and environmentally friendly
products.
Notwithstanding pressures from various quarters, and the noteworthy progress of a few,
typically large firms, manufacturers have been slow to move away from traditional end-of-pipe
strategies toward more prevention-oriented practices. If, as many argue, pollution prevention
pays, what accounts for this slow pace of change? If prevention investments are, in fact, in
the self-interest of the firm, what accounts for the continuing reluctance to move aggressively
toward a more preventative pollution management mode? And why, in light of the publicized
benefits of pollution prevention, do firms, even large sophisticated ones, continue to be
surprised .when prevention-oriented projects produce advantages to the firm far beyond those
expected of many conventional "must-do," compliance-driven capital investments?
The explanation for this apparent contradiction seems to be two-fold: (1) the
organizational structure and behavior of firms inhibits pollution prevention projects from
.entering their decision-making process from the outset, thereby precluding these alternatives
from consideration by the firm altogether; and (2) economic/financial barriers linked to
methods of capital allocation and budgeting after a pollution prevention project successfully
enters the capital budgeting process and competes with other projects for limited capital
resources. A priori, it appears that both these factors, acting in concert, contribute to the
sluggish pace of investment in industrial pollution prevention.
Economic/financial barriers, the second of the explanations we propose, is the focus of
this study. Within a capital budgeting framework, we examine if, and to what extent,
conventional methods of investment analysis act to impede pollution prevention projects in
favor of end-of-pipe alternatives. Two projects actively under consideration by firms in the
pulp and paper sector serve to demonstrate how different definition, measurement, and
allocation of project costs/savings, longer time horizons, and the use of multiple profitability
indices may remove the" biases inherent in conventional financial methods.
THE PULP AND PAPER SECTOR
As a major source of industrial pollution, the pulp and paper sector provides a useful
context for examining these alternative methods. Historically, environmental regulation of the
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industry has focused on reduction of BOD and TSS in water effluent, and particulates, sulfur
dioxide and organic sulfur compounds in air. Reductions of these pollutants have been
achieved principally through end-of-pipe controls. Nonetheless, pollution prevention is by no
means a new concept to pulp and paper firms. In-plant recovery and reuse of pulping
chemicals, for example, is an integral part of the kraft pulping process. Other preventive
measures include: in-plant fiber and water recovery and reuse in the paper mill, counter-
current washing in the pulp mill, and dry wood debarking in the woodroom. These
technologies have been widely implemented to reduce pollution generation and to reduce raw
material and energy costs. Current environmental regulation of toxic air and water pollutants,
toxic constituents in mill sludge, and pulp mill effluent standards for foam, odor, and color are
posing new challenges to pulp and paper firms. Meeting many of these regulations will require
materials and process changes rather than traditional end-of-pipe controls. Dioxin reduction,
for example, requires process changes targeted at reducing dioxin formation, such as decreased
use of chlorine in bleaching or oxygen delignification.
In a compliance context, a mill's choice between an end-of-pipe or a prevention strategy
will depend heavily on the comparative economics of these options. This is so even in
instances where profitability is negative, that is, when the firm expects a net loss on its
investment. Unlike most end-of-pipe technologies, pollution prevention projects tend to reduce
operating costs by reducing waste generation, regulatory activities, and pollution related
liabilities. In addition, investments in pollution prevention may increase revenue by improving
product or corporate image. Including these indirect or less tangible savings in the financial
analysis of projects may enhance the estimated profitability of the prevention strategy, and may
be decisive in selecting a pollution prevention versus an end-of-pipe option. It is at this
decision point that the concepts and methods of Total Cost Assessment (TCA) ~ the
comprehensive, long-term financial analysis of pollution prevention projects — can play a role
in improving the financial picture of a pollution prevention investment, and enhance its
competitiveness vis a vis pollution control projects. TCA techniques can also improve the
projected financial performance of discretionary pollution prevention projects, thereby
increasing their ability to compete for limited capital resources.
CASE STUDIES
To assess how TCA works in practice, we worked in close collaboration with the staff
of two mills to analyze the economics of two pollution prevention projects. The first (Project
1) is a white water and fiber reuse project at a coated fine paper mill. This investment would
permit fiber, filler, and water reuse on two paper machines at all times, thereby conserving raw
materials and reducing water use, wastewater generation, and energy use for fresh and waste
water pumping and freshwater heating. The second (Project 2) is a conversion from
solvent/heavy metal paper coating to aqueous/heavy metal-free coating at a paper coating mill.
This investment would substantially reduce solvent and heavy-metal usage, VOC emissions,
and hazardous waste generation, while increasing water, steam, and electricity usage and
increasing wastewater generation. For both projects, we developed a "company analysis"
comprising costs typically used by the firms. We compared these to "TCA analyses" of the
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same project, in which a full accounting of less tangible, longer term, and indirect costs and
savings was made. To do this, we developed a spreadsheet system called P2/FINANCE to
collect and organize capital and operating cost data, to calculate cash flows and financial
indices, and to perform sensitivity analyses of the case studies.
COST INVENTORY
While cost categories considered in a financial analysis will tend to differ according to
the nature of the project, we can infer from the Company Analyses the types of costs that these
firms typically consider in project analysis. Table ES-1 presents an overview of the costs
estimated in the Company Analyses and the TCA. The TCA column represents a complete set
of known internal costs and revenues affected by the project. By comparing the Company
Analysis column against the TCA column, a picture emerges of the firm's project costing
approach. . .
Direct and Indirect Costs. Had a full financial analysis of the white water/fiber reuse
project (Project 1) been done by the mill prior to this study, energy savings associated with
reduced fresh and waste water pumping and treatment and freshwater heating would have been
omitted. These energy savings, which are included in the TCA, represent a substantial benefit
of the project. Their omission in a traditional financial analysis would have drastically
underestimated the profitability of the investment.
In the case of Project 2, the Paper Coating firm omitted all non-disposal waste
management costs, utilities (energy, water and sewerage), solvent recovery, and regulatory
compliance costs from its analysis of the aqueous conversion project. The firm also omitted
several costs associated with the storage needs and shorter shelf life of aqueous coatings,
namely a steam heating system for the coating storage shed, lost raw material value, and the
cost to dispose of spoiled coating.
Future Liability Costs. In this study we have focused on two general forms of future
liability costs: liability from personal injury or property damage (e.g., Superfund liability
stemming from a leaking landfill), and penalties and'fines for violation of environmental
regulations. In the case of Project 2, the Paper Coating firm did not include an estimate of
avoided future liability costs owing to reduced hazardous waste disposal in their own financial
analysis. They did. however, allude to this benefit in a qualitative way in their Appropriations
Request: "...major reductions in levels of fugitive emissions, and amounts of solid hazardous
waste going to landfill, -is very positive from a regulatory and community standpoint". The
TCA developed for this project includes an estimate of avoided future liability. Since Project
1 does not involve hazardous materials or waste, neither the Company Analysis nor the TCA
contains a future liability estimate.
Less Tangible Benefits. Less tangible benefits from pollution prevention investments.
such as increased revenue from enhanced product quality, company or product image, and
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reduced worker health maintenance costs or productivity are certainly the most difficult to
predict and quantify. Neither Company Analyses nor TCAs contain estimates of less tangible
benefits. In the case of Project 2, the coated paper product is sold domestically, on the basis
of cost, visual appearance, and performance durability, to book publishers and other
intermediate product manufacturers. Although the company expects some quality
improvements using aqueous coating, it does not anticipate an increase in market value.
Therefore, it expects no increase in domestic sales as a result of the conversion to the
aqueous/heavy metal-free coating. The company hopes to improve its competitive advantage
in the European market if the European Economic Community implements lead-free packaging
standards (which would apply to books) as expected. However, it would not speculate on the
potential revenue effects associated with increased European market share.
The Coated/Fine Paper Mill does not expect an increase in market share or product
value from its white water/fiber reuse project. Both the mills are manufacturers of
intermediate, rather than consumer products, and cannot directly market their products on the
basis of environmental performance in the way that a consumer products company like Procter
and Gamble can and does.
A reduction in solvent use at the Paper Coating firm will. certainly reduce worker
exposure to fugitive solvent emissions, and the elimination of nitrocellulose from the coating
mixture will reduce fiammability and explosivity hazards. While reduced solvent exposure
may result in a lower incidence of worker illness over the long-term, and the elimination of
nitrocellulose may result in fewer worker injuries, we did not have adequate information to
estimate the potential impact of these benefits on either the company's health care costs or
long-term worker productivity. This issue was dealt with qualitatively in a section of an
Appropriations Request, developed by the company, called "Safety/Health Impact of
Converting from Solvent to Aqueous Coating", which listed specific project benefits that will
improve safety and industrial hygiene.
Many company representatives noted that project benefits are more persuasive if they
are monetized and included in the project financial analysis. However, when costs are difficult
or impossible to monetize, a qualitative approach may be more credible with management.
Omitted non-environmental costs. In developing the TCAs for the two projects, we
attempted to add to the Company Analyses any capital or operating costs or savings that could
be attributed to the project and reasonably estimated. While our focus was on environmental
costs typically omitted from project analyses, the process of developing a more comprehensive
list of costs (or "casting the cost net wider") unearthed other, "non-environmental" costs that
were not considered by the company. In the case of Project 2, all previous company analyses
of the aqueous/heavy-metal free conversion had omitted the costs of heating system installation,
the energy needed to prevent the aqueous coating from freezing, and the additional energy
needed to dry aqueous versus solvent-based coating. While the latter cost was acknowledged
by several production engineers and managers in meetings with Tellus, it had never been
estimated nor included in previous analyses.
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The effect of such costs on a project's financial performance depends upon whether the
item represents a cost or a savings for the project. In the case of Projects land 2, these
non-environmental costs tended to increase the total cost of the project by adding to capital and
operating costs. While this finding is probably not a surprise to those who prepare project
analyses, it is important to point out that the TCA process may reveal additional costs as well
as savings for the project. If the financial impact from the addition of regulatory compliance
or waste management activities is marginal, they may be negated by the addition of one or two
previously omitted non-environmental costs.
FINANCIAL INDICATORS
Financial indicators are a critical, though not exclusive, ingredient in justifying pollution
prevention projects. Firms typically use such indicators as guideposts rather than decisive
elements in judging the merits of a proposed project. Their application tends to be flexible,
that is, subject to substantial management discretion as proposals move through the formal or
informal budgeting process and compete against one another for scarce capital.
For the relatively large companies included in this study, payback (or the slightly more
sophisticated ROI) is typically used as a first screen. If a project passes a prescribed hurdle
rate, a more m-depth analysis that computes NPV and/or IRR is common. The Paper Coating
Company uses ROI to screen proposed projects before subjecting them to more in-depth NPV
and IRR analyses. The Fine/Coated Mill uses payback in a similar fashion. This practice
provides the project proponent with an informal estimate of expected performance prior to
investment of staff resources (and personal capital) in advocating a proposal. Once this
milestone is passed, the proposal typically moves into a divisional or sectoral review where
more complex calculations are developed to capture the longer-term costs/savings.
In none of these cases is the hurdle rate inflexibly applied. Instead, there are
perceptions associated with each project that are defined by the project's place in the strategic
thinking of top management and the degree to which outside pressures from customers
regulators, or the community are applied. In the case of the Coated Fine Paper Mill, the
professed hurdle rate for projects is a 2 year payback. However, certain production-oriented
projects have been implemented without meeting this rate, primarily because there was a
general perception among decision-makers that these projects were needed to maintain
productivity. On the other hand, discretionary environmental projects are more rigidly
measured against the company's hurdle rate. This seems to be a result of an impression that
environmental projects by nature are virtually always unprofitable.
To examine the effect of the choice of financial indicators and time horizon, we created
two functional categories of indices: discounted cash flow methods that consider a stream of
future cash flows for the investment (e.g. NPV and IRR). and one which does not (e.g. simple
payback period).
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TIME HORIZON
Time horizon, of course, is closely tied to financial indicators. Simple payback and ROI
calculations are not capable of capturing long-term costs/savings, a particularly severe
shortcoming in the case of liability estimation where benefits may materialize 10 years or more
into a project's lifecycle. NPV and IRR, on the other hand, can account for costs and savings
as they occur in future years. Their use is typically associated with large firms and large
investments whose market and budgeting horizons are expansive, and who are able to wait
many years for a stream of benefits to materialize.
In preparing the TCA for the Paper Coating Mill, managers indicated that a time
horizon of 10 years is typical for major investments. The need for extending this figure to 15
years to capture the liability avoidance benefits became evident in preparing the TCA analysis;
if the time horizon was less than 13 years, the liability estimate would not have been
incorporated into the financial indicators. In the case of the Fine/Coated Paper Mill, once a
discretionary project such as the white water/fiber reuse system passes an informal payback
screening, it is subjected to a 10 year discounted cashflow analysis. Since the TCA for this
project did not involve any costs (e.g. future liability costs) that would be incurred in the out-
years, the time horizon is less critical to capturing the full financial impact of the project. In
any case, the linkage between financial indicator, time horizon, and cost inclusion is a powerful
rationale for promoting and practicing TCA in pollution prevention project analysis.
PROFITABILITY ANALYSIS
The comparative analyses for each project yield substantially different results. For
Project 1, the white water and fiber reuse investment, the net present value (over 15 years) for
this SI.5 million capital expenditure shifts from $0.36 million in the Company Analysis to
S2.85 million using a TCA approach; the internal rate of return (IRR) increased from 21% to
48%; and the simple payback of 4.2 years decreased to 1.6 years, well within the mill's 2-year
payback rule of thumb. By excluding the savings associated with freshwater pumping,
treatment, and heating, and waste water pumping, the Company Analysis makes the project
appear substantially less profitable than it actually is.
Contrasting results are produced for Project 2, the aqueous conversion investment. NPV
for this $0.9 million capital expenditure shifts from -$0.2 million to -$0.4 million in the
company versus TCA analyses, respectively; IRR shifts from 11% to 6%; and simple payback
rises from 7.6 to 11.7 years. The inclusion of previously omitted savings for waste
management, regulatory compliance, and future liability in the TCA are outweighed by the
previously omitted utility costs. As a result, the TCA analysis illustrates that the proposed
project is actually less profitable than originally thought. Nonetheless, the exercise achieves
its ultimate goal - providing a clear, comprehensive picture of the investment option.
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IMPLICATIONS
Analysis of this limited sample of two projects does not suggest that, a priori, more
comprehensive treatment of project costs and savings necessarily yields higher performance for
prevention investments. Much depends on the original capital cost of the project, the
completeness of the company analysis, and the magnitude and timing of indirect and less
tangible benefits. And, surprisingly, TCA is equally likely to turn up additional costs as well
as additional savings, potentially diminishing the appeal of prevention investments. Moreover,
the effort expended in preparing the TCA analysis, though partially attributable to startup costs
of any new practice, is substantial enough to make even large firms wary of adopting such an
approach for all projects competing for capital resources.
The limited number of cases examined here precludes generalizations about overall
corporate receptivity to TCA approaches and the degree to which pollution prevention will be
accelerated by its adoption. Within the limitations. of our study, however, it is clear that TCA
can serve as valuable tool for translating discretionary judgements into concrete dollar values
during the capital budgeting process. Insofar as pollution prevention projects produce less
'tangible and indirect costs and benefits, TCA equips managers to develop a more precise
estimation of the real financial returns to such projects. Though TCA does not insure an
attractive profitability level for prevention projects, the cost characteristics of such projects
suggests that their financial performance in general will be enhanced by TCA. This is likely
to be particularly true for industrial prevention projects that are materials and process-focused,
that is, well upstream in the production process. Over the longer term, TCA can serve as a
substantial force in recasting the "must-do" and "inherent loser" image of environmental
projects into a more positive, profit-adding and market-expanding image.
Several approaches for promoting TCA in the context of EPA's pollution prevention
strategy emerge from this study. In general, it is clear that moving firms to modify their
analytical procedures requires a belief that TCA will produce a clearer picture of the
profitability of prevention projects and thereby managerial decision-making. Thus, the primary
goal of a promotion program should be to convince firms that TCA is not simply another
regulatory mandate, but a vehicle for rationalizing their internal capital budgeting process.
More concretely, EPA has already worked to promote TCA by developing the Pollution
Prevention Benefits Manual, the Waste Minimization Opportunity Assessment Manual, and
sponsoring the initial work on PRECOSIS, all of which contain discussions of TCA concepts
and provide analytical tools. Further efforts to disseminate more widely these and other tools
such as P2/FINANCE, a tool developed for this study, will accelerate the advancement of the
TCA concept. Published case studies which use a TCA approach to project financial analysis
could be a valuable supplement to past initiatives.
At the state level, TCA may be built into pollution prevention policies and programs
in several ways. State technical assistance programs may offer TCA guidance and training as
a complement to their technical services, by providing TCA training seminars, with specialized
8
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modules aimed at large versus small firms, or for firms in certain lines of business. A number
of states have instituted requirements for industry to develop pollution prevention plans that
must contain technical and economic feasibility assessments of specific prevention projects.
The New Jersey Pollution Prevention Act, for example, explicitly requires that plans include
a comprehensive analysis of the costs associated with the use, generation, release or discharge
of hazardous substances for current production processes and the savings realized by
investments in pollution prevention. Planning for Success Through Waste Reduction, the
planning guidance document created by the Washington State Department of Ecology under
the State's Hazardous Waste Reduction Act, instructs companies to evaluate the costs and
benefits of selected waste reduction options over a five year period. It also requires firms to
describe the accounting systems used to track hazardous substance and waste management costs
which must include "liability, compliance, and oversight costs".
Requiring a TCA approach in pollution prevention planning may direct firms to
incorporate unconventional cost items and/or longer time horizons to enhance the
competitiveness of prevention investments. The long-term effectiveness of this approach,
however, is unproven and should be approached cautiously and with a strong emphasis on the
company self-interest alluded to earlier. While rigid, prescriptive approaches are undesirable,
some type of standard could facilitate the implementation of emerging federal and state
regulations requiring TCA in pollution prevention planning.
The limited sample size of firms in this study allows for only indicative findings that
must be corroborated by the analysis of additional cases. Existing TCA methods have been
available for several years, yet no systematic assessment of user experience among the several
hundred purchasers of various systems is available. This presents a potentially rich data base
for further assessing the organizational and economic issues in TCA adoption which we
uncovered in this study.
Quantifying the benefits of green technologies, green products and green corporate
image remains a major challenge. It is precisely these benefits that are heard by corporate
managers as reasons for approving otherwise marginal projects. Developing methodologies to
quantify these benefits and incorporate them into project financial analysis is an unfinished
task.
Finally, what is financially optimal for the firm, of course, is not necessarily optimal
from a social cost standpoint. In this sense, TCA is no substitute for lifecycle assessment
(LCA), in which the choice of a material input or the manufacture of a product is assessed for
its full societal costs regardless of whether they fall within or outside the purview of the firm.
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Table ES-1 Overview of Cost Inclusion by Company and TCA for Projects'1 and 2
X = Cost(s) Included
P = Cost(s) Partially Included
Capital Costs
Purchased Equipment
Materials (e.g. Piping, Elec.)
Utility Systems
Site Preparation
Installation
Engineering/Contractor
Start-up/Training
Contingency
Permitting
Initial Chemicals
Working Capital
Salvage Value
Operating Costs
Direct Costs:3
Raw Materials/Supplies
Waste Disposal
Labor
Revenues - General
Revenues - By-products
Other:
Transportation
Indirect Costs:4
Waste Management
Hauling
Storage
Handling
Waste-end Fees/Taxes
Hauling Insurance
Utilities
Energy
Water
Sewerage (POTW)
Pollution Control/Solvent Recovery
Regulatory Compliance
Insurance
Future Liability
Project 1'
Company TCA
Project 22
Company TCA
X
X
X
X
X
X
P
X
P
X
Notes:
I.
X
X
X
X
X
X
X
X
X
X
X
P
P
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
White water/fiber reuse project
Solvent/heavy-metal to aqueous/heavy metal-free coating conversion
We use the term "direct costs" here to mean costs that are typically allocated to a product or process line (i.e.
not charged to an overhead account) and are typically included in project financial analysis.
We use the term "indirect costs" here to mean cost that ate typically charged to an overhead account and
typically not included in project financial analysis.
10
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Table ES-2 Summary of Financial Data for Project 1 - White Water and Fiber Reuse
Project
Total Capital Costs
Annual Savings (BIT)*
Financial Indicators
Net Present Value - Years 1-10
Net Present Value - Years 1-15
Internal Rate of Return - Years 1-10
Internal Rate of Return - Years 1-15
Simple Payback (years)
Company Analysis
$1,469,404
$ 350,670
$ 47,696
$ 360,301
17%
21%
4.2
TCA
$1,469,404
$ 911,240
$2,073,607
$2,851,834
46%
48%
1.6
* Annual operating cash flow before interest and taxes
Table ES-3 Summary of Financial Data for Project 2 - Aqueous/Heavy Metal Conversion
Project
Total Capital Costs
Annual Savings (BIT)*
Financial Indicator
Net Present Value - Years 1-10
Net Present Value - Years 1-15
Internal Rate of Return - Years 1-10
Internal Rate of Return - Years 1-15
Simple Payback (years)
moanv Analvsis
$893,449
$118,112
TCA
$923,449
$ 79,127
($314,719)
($203,643)
6%
11%
7.6
($480,512)
($395,625)
0%
6%
11.7
* Annual operating cash flow before interest and taxes
11
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